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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED NOVEMBER 30, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____ TO ____.
COMMISSION FILE NUMBER: 0-17442
MERITAGE HOSPITALITY GROUP INC.
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2730460
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
40 PEARL STREET, N.W., SUITE 900
GRAND RAPIDS, MICHIGAN 49503
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (616) 776-2600
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on which Registered
Common Shares, $0.01 par value Chicago Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of February 19, 1999, there were 5,742,586 common shares of the Registrant
outstanding. The aggregate market value of the common shares held by
non-affiliates at that date was $5,624,210 based on the average high and low bid
price on the OTC Bulletin Board on that date.
Portions of the Registrant's Proxy Statement to be filed with the Commission for
its 1999 Annual Meeting are incorporated by reference in Part III as specified.
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MERITAGE HOSPITALITY GROUP INC.
INDEX TO ANNUAL REPORT ON FORM 10-K
PART I PAGE
----
Item 1 - Business 3
Item 2 - Properties 7
Item 3 - Legal Proceedings 9
Item 4 - Submission of Matters to Vote of Security-Holders 9
PART II
Item 5 - Market for Registrant's Common Equity and Related Stockholder Matters 10
Item 6 - Selected Financial Data 11
Item 7 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
Item 7A - Quantitative and Qualitative Disclosures About Market Risk 25
Item 8 - Financial Statements and Supplementary Data 25
Item 9 - Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure 25
PART III
Item 10 - Directors and Executive Officers of the Registrant 25
Item 11 - Executive Compensation 25
Item 12 - Security Ownership of Certain Beneficial Owners and Management 25
Item 13 - Certain Relationships and Related Transactions 25
PART IV
Item 14 - Exhibits, Financial Statement Schedules, and Reports on Form 8-K 26
Certain statements contained in this report that are not historical
facts constitute forward-looking statements, within the meaning of the Private
Securities Litigation Reform Act of 1995, and are intended to be covered by the
safe harbors created by that Act. Reliance should not be placed on
forward-looking statements because they involve known and unknown risks,
uncertainties and other factors which may cause actual results, performance or
achievements to differ materially from those expressed or implied. Any
forward-looking statement speaks only as of the date made. The Company
undertakes no obligation to update any forward-looking statements to reflect
events or circumstances after the date on which they are made.
Statements concerning expected financial performance, on-going business
strategies and possible future action which the Company intends to pursue to
achieve strategic objectives constitute forward-looking information.
Implementation of these strategies and the achievement of such financial
performance are each subject to numerous conditions, uncertainties and risk
factors. Factors which could cause actual performance to differ materially from
these forward looking statements include, without limitation, competition;
changes in local and national economic conditions; changes in consumer tastes
and views about the nutritional quality of quick-service food; severe weather;
changes in travel patterns; increases in food, labor and energy costs; the
availability and cost of suitable restaurant sites; fluctuating insurance rates;
the availability of an adequate number of employees; the general reputation of
Wendy's restaurants; and the recurring need for renovation and capital
improvements. Also, the Wendy's restaurants are subject to extensive government
regulations relating to, among other things, zoning, minimum wage, public health
certification, and the operation of its restaurants. Because Meritage's
restaurant operations are concentrated in smaller urban areas of Michigan, a
marked decline in the Michigan economy could adversely affect Meritage's
operations.
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PART I
ITEM 1. BUSINESS
THE COMPANY
Meritage Hospitality Group Inc. was incorporated in 1986 and is engaged
in the quick-service restaurant business through its operation of 26 "Wendy's
Old Fashioned Hamburgers" restaurants in Western and Southern Michigan. Each
restaurant is operated pursuant to a franchise agreement with Wendy's
International, Inc., the franchisor of the nationally recognized quick-service
restaurant system that operates under the "Wendy's" brand name. Meritage opened
its 26th Wendy's restaurant on February 18, 1999, and currently has two
additional Wendy's restaurants under construction.
Meritage's growth strategy is to expand its Wendy's business through
the development of new restaurants within the Company's designated market area,
and through accretive acquisitions or joint ventures outside of the designated
market area. This plan includes developing and acquiring 20 to 30 additional
Wendy's restaurants over the next five years. At present, Meritage is the only
publicly-held "Wendy's Old Fashioned Hamburgers" restaurant franchisee in the
United States. In 1998, the Restaurant Finance Monitor ranked Meritage 157 in
its list of top restaurant franchises in the United States.
Meritage's principal executive office is located at 40 Pearl Street,
N.W., Suite 900, Grand Rapids, Michigan 49503. Its telephone number is (616)
776-2600 and its facsimile number is (616) 776-2776. The Company's 26 Wendy's
restaurants are owed or operated by Wendy's of Michigan, a Michigan limited
partnership that is owed by MHG Food Service Inc., a wholly-owed subsidiary of
Meritage. S & Q Management, LLC, a Michigan limited liability company owned by
Robert E. Schermer, Jr. and Ray E. Quada, is the sole general partner of Wendy's
of Michigan. For convenience, Meritage and its subsidiaries are collectively
referred to as "Meritage" or "the Company" throughout this report.
OPERATIONS
Meritage's restaurants are located in the Michigan counties of Allegan,
Calhoun, Kalamazoo, Kent, Muskegon, Ottawa and Van Buren. This includes the
metropolitan areas encompassing the cities of Grand Rapids, Kalamazoo, Battle
Creek, Muskegon and Holland.
Menu
Each Wendy's restaurant offers a diverse menu containing a variety of
food items, featuring hamburgers, chicken sandwiches and pita sandwiches, all of
which are prepared to order with the customer's choice of condiments. The
Wendy's menu includes other items such as baked and french fried potatoes,
freshly prepared salads, soft drinks, "Frosty" desserts and children's meals.
Each Wendy's restaurant features soft drink products supplied by the Pepsi-Cola
Company and its affiliates. Wendy's International maintains significant
discretion over the menu items that are offered in the Company's restaurants.
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Restaurant Layout and Operations
The Company's restaurants typically range from 2,700 to 3,200 square
feet with a seating capacity between 90 and 130 people, and are typically open
from 10:00 a.m. until midnight. Generally, the dining areas are carpeted and
informal in design, with tables for two to four people. All restaurants also
feature a drive-through window. Sales to drive-through customers accounted for
over half of the total restaurant sales in fiscal 1998.
A comprehensive reporting system provides restaurant sales and
operating data (including product sales mix, food usage and labor cost
information) with respect to each of the Company's restaurants. Physical
inventories of all food items are taken weekly, and inventories of critical food
items are taken twice a day.
Marketing and Promotion
Wendy's International requires that at least 4% of the Company's
restaurant sales be contributed to an advertising and marketing fund, 2.5% of
which is used to benefit all restaurants owned and franchised by Wendy's
International. The Wendy's National Advertising Program uses these moneys to
develop advertising and sales promotion materials and concepts to be implemented
nationally. The remainder of the fund must be used on local advertising. The
Company typically spends local advertising dollars in support of national
television advertising, local television and radio advertising, print media,
local promotions and community goodwill projects.
Raw Materials
The Company's restaurants comply with uniform recipe and ingredient
specifications provided by Wendy's International. Food and beverage inventories
and restaurant supplies are purchased from independent vendors that are approved
by Wendy's International. Wendy's International does not sell food or supplies
to the Company.
The Company has not experienced any significant shortages of food,
equipment, fixtures or other products which are necessary to restaurant
operations. While no such shortages are anticipated, the Company believes that
alternate suppliers are available if any shortage were to occur.
Relationship with Wendy's International
Meritage operates its restaurants pursuant to consent and franchise
agreements (one franchise agreement for each restaurant) with Wendy's
International. These agreements grant privileges such as the right to utilize
Wendy's International's trademarks, service marks, designs and other proprietary
rights (such as "Wendy's" and "Wendy's Old Fashioned Hamburgers") in connection
with the operation of its Wendy's restaurants. These agreements also impose
requirements regarding the preparation and quality of food products, the level
of service, and general operating procedures. The franchise agreements currently
in place expire in approximately 20 years. Subject to certain conditions, the
franchise agreements can be renewed for an additional 10 years.
The franchise agreements with Wendy's International provide, among
other things, that (i) a change in the operational control of Wendy's of
Michigan, (ii) the removal or resignation of S & Q Management as the sole
general partner of Wendy's of Michigan, or (iii) the removal or resignation of
any guarantor of the Company's franchise agreements, cannot occur without the
prior consent of
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Wendy's International. In addition, any proposed sale of the Wendy's business,
interests or franchise rights is subject to the consent of, and a right of first
refusal by, Wendy's International. These agreements also grant Wendy's
International wide discretion over many aspects of the restaurant operations,
and often require the consent of Wendy's International to carry out certain
operational transactions. If Meritage requires the consent of Wendy's
International to proceed with its business plans but such consent is not
obtained, Meritage will not be able to proceed with its plans which, in turn,
could adversely effect Meritage's growth strategy. If Meritage were to proceed
without Wendy's International's consent, Wendy's International could terminate
the franchise agreements or exercise its right to purchase the Wendy's
restaurants at fair market value.
Part of Meritage's business strategy is to expand its restaurant
operations through the development and acquisition of additional Wendy's
restaurants. In addition to paying monthly royalty fees, Meritage is required to
pay Wendy's International technical assistance fees upon the opening of new
Wendy's restaurants. Meritage is permitted to develop new Wendy's restaurants
and convert competitive units located in its designated market area (the
Michigan counties of Allegan, Calhoun, Kalamazoo, Kent, Muskegon, Ottawa and Van
Buren) subject to the standard expandability criteria and site standards of
Wendy's International. Meritage is prohibited from acquiring or developing new
Wendy's restaurants outside of its designated market area unless the prohibition
is waived by Wendy's International in its sole and absolute discretion. Wendy's
International also prohibited Meritage from acquiring or developing any other
types of quick-service restaurants within Meritage's designated market area, or
outside of Meritage's designated market area if the restaurant sells hamburgers,
chicken sandwiches or products similar to Wendy's International and is located
within a three mile radius of another Wendy's restaurant.
The reputation of Meritage's restaurants are largely dependent on the
entire Wendy's restaurant chain, which in turn is dependent upon the management
and financial condition of Wendy's International and the performance of Wendy's
restaurants operated by other Wendy's franchisees. Should Wendy's International
be unable to compete effectively with similar restaurant chains in the future,
Meritage would be materially and adversely affected. Furthermore, many of the
attributes which lead to the success of Wendy's operations are factors over
which Meritage has no control, such as marketing, introduction of new products,
quality assurance and other operational systems.
Meritage cannot conduct its Wendy's operation without its affiliation
with Wendy's International. Any termination of the franchise agreements would
have a material adverse effect on Meritage's financial condition and results of
operations.
Personnel
Meritage employs approximately 1,000 people of which approximately 175
are full-time employees. The Company believes that it has good relations with
its employees.
COMPETITION AND INDUSTRY CONDITIONS
The food service industry is one of the largest sectors of the nation's
economy, generating an estimated $320 billion of revenue in 1997, of which 31%
was attributable to the quick-service industry. As a whole, the quick-service
segment has consistently grown for more than 20 years, and indications are that
this growth will continue. Historic changes in domestic lifestyles, favoring
greater convenience, has significantly impacted this trend. In addition, a
burgeoning household income, brought about by a strong national economy, has
increased the spending on food away from home. Because of these trends,
competition in the quick-service restaurant segment is, and can be expected to
remain, intense.
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Most of the Wendy's restaurants operated by the Company are located in
close proximity to their principal quick-service restaurant competitors (e.g.
McDonald's, Burger King and Taco Bell) which compete on the basis of price,
service, location, food quality, menu variety and new product development. These
competitors have attempted to draw customer traffic through a strategy of deeply
discounting the price of their products. However, neither Wendy's International
nor the Company believe this is a profitable long-term strategy. Both Wendy's
International and the Company believe that the competitive position of a Wendy's
restaurant is enhanced by its use of fresh ground beef, a unique and diverse
menu, promotional products, a wide choice of condiments, and the atmosphere and
decor of its restaurants.
The following table compares the Company's average Wendy's restaurant
same store sales to (i) the average same store sales of Wendy's International's
company-owned restaurants and (ii) to all Wendy's franchised restaurants.
=============================================================================
YEAR MERITAGE OPERATED WENDY'S OPERATED ALL FRANCHISED
RESTAURANTS RESTAURANTS * RESTAURANTS *
-----------------------------------------------------------------------------
1996 $1,052,000 $1,049,000 $ 978,000
-----------------------------------------------------------------------------
1997 $1,074,000 $1,111,000 $1,017,000
-----------------------------------------------------------------------------
1998 $1,082,000 $1,174,000 $1,031,000
=============================================================================
* Source: Wendy's International, Inc.
The Company intends to achieve growth by (i) developing new Wendy's
restaurants in its existing market, (ii) acquiring Wendy's restaurants in other
markets, and (iii) increasing sales at Wendy's restaurants currently operated by
the Company. The Company may also explore other restaurant acquisitions that
would complement its Wendy's business.
The restaurant industry is subject to seasonal fluctuations. Like the
rest of the quick-service industry, traffic typically increases during the
summer months, which results in increased revenues during those months. During
fiscal 1998, food service revenue generated by quarter was as follows: first
quarter - 22%; second quarter - 25%; third quarter - 27%; and fourth quarter -
26%.
RISKS AND GOVERNMENTAL REGULATIONS
Meritage is subject to numerous risks inherent in the food service
industry. These include, among others, changes in local and national economic
conditions; changes in consumer tastes and concerns about the nutritional
quality of quick-service food; severe weather; changes in travel patterns;
increases in food, labor and energy costs; the availability and cost of suitable
restaurant sites; fluctuating insurance rates; the availability of an adequate
number of hourly-paid employees; the general reputation of Wendy's restaurants;
and the recurring need for renovation and capital improvements. Also, the
Company is subject to extensive federal, state and local government regulations
relating to, among other things, zoning and the operation of its restaurants.
Congress increased the minimum wage to $5.15 per
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hour in 1997. Further changes regarding minimum wage or other laws governing the
relationship with employees (e.g. overtime wage and health care coverage) could
have an adverse effect on the Company's operations.
The Company's restaurants are also subject to public health
certification regarding the preparation and sale of food. The Company believes
its operations would be adversely affected if these permits were terminated. The
Company does not anticipate, however, that its permits will be terminated.
SALE OF HOTEL PROPERTIES
From its commencement until this past fiscal year, the Company was also
engaged in the lodging business through its ownership and operation of three
full service hotels in Michigan. All three hotels were recently sold so that the
Company could focus exclusively on expanding its restaurant business. On
November 30, 1997, the St. Clair Inn (St. Clair, Michigan) and certain
associated assets were sold for $3,800,000. On June 15, 1998, the Grand Harbor
Resort & Yacht Club (Spring Lake, Michigan) and certain associated assets were
sold for $4,500,000. On September 1, 1998, the Thomas Edison Inn (Port Huron,
Michigan) and certain associated assets were sold for $12,200,000. The proceeds
from these sales were primarily used to reduced the Company's long-term
indebtedness. As a result of these sales, the Company's began accounting for the
operations of the former lodging business as discontinued operations effective
May 31, 1998.
OTHER ASSETS
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During fiscal 1998, the Company owned other assets which did not
directly relate to its restaurant or its discontinued lodging business. Most of
these assets have since been disposed of including: (i) approximately 5.5 acres
of undeveloped land adjacent to the Thomas Edison Inn in Port Huron, (ii) a
55-slip marina condominium development which borders the Grand River in Spring
Lake Michigan, (iii) life insurance policies with a face value of $5.1 million
on the life of the Company's former President and Chief Executive Officer, (iv)
a note receivable from the sale of the Grand Harbor Resort & Yacht Club in the
outstanding principal amount of $1,375,000 (sold on a recourse basis), and (v) a
note receivable from the sale of the Thomas Edison Inn in the outstanding
principal amount of $1,844,617 (of which $1,100,000 was sold on a recourse
basis). The Company also holds a note receivable from the sale of shares in the
outstanding principal amount of $9,750,000.
ITEM 2. PROPERTIES.
Each Wendy's restaurant is built to specifications provided by Wendy's
International as to its exterior style and interior decor. The restaurants are
one-story brick buildings constructed on sites of approximately 40,000 square
feet, with parking for approximately 45 vehicles. The typical new free-standing
restaurant contains about 3,000 square feet and has a food preparation area, a
dining room with seating capacity for 95 persons, and a double pick-up window
for drive-through service.
Regarding its 26 Wendy's restaurants, the Company (i) owns the land and
buildings comprising 11 restaurants, (ii) leases the land and buildings
comprising 14 restaurants, and (iii) owns the building and leases the land
comprising one restaurant. The term of the leases (including options to renew)
range from 1 to 22 years. The structures range from being brand new to 25 years
old. The land and buildings owned by the Company are subject to encumbrances
described in "Financing and Encumbrances."
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The Company leases approximately 4,600 square feet of office space
located at 40 Pearl Street, N.W., Suite 900, Grand Rapids, Michigan which serves
as the corporate headquarters and the registered office of the Company and its
subsidiaries. The Company also leases approximately 3,000 square feet of office
space located at 4613 West Main, Kalamazoo, Michigan 49006 as its operating
office.
The Company believes that its properties are adequately covered by
insurance.
FINANCING AND ENCUMBRANCES
- --------------------------
During fiscal 1998, the Company completed a significant refinancing
program. The Company used proceeds from the sale of certain assets (see "Sale of
Hotel Properties") to pay down a substantial portion of its long-term
indebtedness. These sales, combined with the financing and refinancing described
below, allowed for the complete payment of all long-term indebtedness with the
Company's former primary lender, which totaled $20,495,000 as of November 30,
1997. The notes payable carried interest rates ranging from 11.25% to prime plus
8%, and had a weighted average interest rate of 12.7%. The debt retirement also
included the payment of a $2,000,000 (prime plus 1%) revolving term note payable
with National City Bank.
The Company entered into several loan agreements with Captec Financial
Group, Inc. ("Captec") as part of a $10,000,000 financing package which included
(i) the purchase of five restaurants which the Company previously leased, and
(ii) the refinancing of six restaurants of which the Company already owned the
real estate. The loans with Captec have terms ranging from fifteen to twenty
years, require monthly payments of $83,174 through October 2018, and carry
interest rates that range from 7.77% to 8.15%. The loans are secured by the real
estate of the Company-owed restaurants and the business value of certain
restaurants, and contain financial covenants which require the maintenance of
certain coverage ratios. In addition to the coverage ratio requirements, the
loan covenants limit the amount of currently generated operating cash flow that
can be utilized to fund corporate level expenses.
In the fourth quarter of fiscal 1998 and in the first quarter of fiscal
1999, the Company entered into additional loan agreements with Captec to finance
the real estate associated with two new Wendy's restaurants that were then under
construction. The loans, which total $1,940,000, have a 20-year term at a fixed
interest rate equal to 2.75% above the 10-year treasury rate on the date
construction on each respective restaurant is completed. Based on treasury rates
as of the date of this report, the rate would be approximately 7.75%. The loans
are secured by the real estate of the new restaurants and are subject to
financial covenants similar to those described in the preceding paragraph.
The Company also holds a forward commitment from Captec to provide
$3,750,000 in additional financing to fund the land purchase, building
construction, and equipment packages associated with the development of three
new Wendy's restaurants. The term of this indebtedness would be fifteen to
twenty years on the real estate, and seven years on the equipment packages. The
interest rate would be 4% over similar term treasury rates with a floor of 9% on
real estate, and 5% over similar term treasury rates with a floor of 10.5% on
equipment. The Company is under no obligation to utilize this commitment.
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ITEM 3. LEGAL PROCEEDINGS.
The Company is involved in certain routine legal proceedings which are
incidental to its business. All of these proceedings arose in the ordinary
course of the Company's business and, in the opinion of the Company, any
potential liability of the Company with respect to these legal actions will not,
in the aggregate, be material to the Company's financial condition or
operations. The Company maintains various types of insurance standard to the
industry which cover most legal actions brought against the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS.
There were no matters submitted to a vote of security holders of the
Company during the fourth quarter of fiscal 1998.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET INFORMATION
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Meritage's common shares are quoted on the OTC Bulletin Board under the
symbol "MHGI." Prior to October 18, 1995, there was no established public
trading market for the Company's common shares.
The following table sets forth the high and low bid prices for the
Company's common shares for the two most recent fiscal years as quoted on the
OTC Bulletin Board:
==================================================================
HIGH LOW
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FISCAL YEAR ENDED NOVEMBER 30, 1997
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First Quarter $6.25 $5.38
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Second Quarter $5.25 $4.00
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Third Quarter $4.00 $2.63
------------------------------------------------------------------
Fourth Quarter $3.25 $2.63
==================================================================
==================================================================
HIGH LOW
------------------------------------------------------------------
FISCAL YEAR ENDED NOVEMBER 30, 1998
------------------------------------------------------------------
First Quarter $3.13 $1.00
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Second Quarter $2.00 $1.03
------------------------------------------------------------------
Third Quarter $1.56 $1.06
------------------------------------------------------------------
Fourth Quarter $1.63 $1.00
==================================================================
The Company's common shares are also listed on the Chicago Stock
Exchange under the symbol "MHG." However, no meaningful trades were reported by
the Chicago Stock Exchange during the past fiscal year.
HOLDERS
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As of February 19, 1999, there were approximately 775 record holders of
the Company's common shares, which the Company believes represents approximately
1,300 beneficial holders.
DIVIDENDS
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No dividends on Meritage's common shares were paid in the two most
recent fiscal years. Because the Company intends to reinvest any available cash
into the development of new Wendy's restaurants, it does not intend to pay any
dividends in fiscal 1999.
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ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth the selected financial information of
the Company.
(In thousands except for per share information)
YEAR ENDED NOVEMBER 30,
-------------------------------------------------------------------------
1998 1997 1996 1995 1994
(RESTATED)* (RESTATED)* (RESTATED)* (RESTATED)*
-------------------------------------------------------------------------
SUMMARY OF OPERATIONS
- ---------------------
Continuing Operations
Total revenue $27,044 $26,860 $ 2,099 $ -- $ --
Operating Expenses 27,590 27,534 2,368 -- --
Operating income (loss) (546) (674) (269) -- --
Earnings (loss) from continuing operations (1,374) (1,935) 268 -- --
Discontinued Operations
Loss from operations (479) (1,058) (2,193) (2,049) (27)
Gain on disposal of business segment 3,711 1,479 -- -- --
Net earnings (loss) 1,131 (1,691) (1,926) (2,049) (27)
Preferred stock dividends 108 102 -- -- --
Net earnings (loss) on common shares 1,023 (1,793) (1,926) (2,049) (27)
Earnings (loss) per common share
Earnings (loss) from continuing operations $ (0.30) $ (0.63) $ .09 $ -- $ --
Net earnings (loss) $ 0.21 $ (0.56) $ (0.62) $ (1.13) $(0.02)
BALANCE SHEET DATA
- ------------------
Property & equipment $13,183 $ 7,518 $ 7,652 $ -- $ --
Net assets of discontinued operations (594) 840 267 3,055 5,225
Total assets 24,964 13,814 14,891 3,055 5,225
Long-term obligations (1) 13,513 10,447 9,715 -- --
Stockholders' equity 5,434 30 2,021 3,055 5,225
Cash dividends declared per common share $ 0. 00 $ 0.00 $ 0.50 $ 0.00 $ 0.00
(1) For comparative purposes, long-term obligations include current portions of
long-term obligations.
* Effective May 31, 1998, the Company began accounting for the operations of
the lodging industry segment as discontinued operations. The consolidated
financial statements beginning on page M-1 have been restated for all
periods presented to reflect the results of operations and net assets of
the lodging industry segment as discontinued operations. The selected
financial data above has also been restated to reflect the lodging industry
segment as a discontinued operation.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS
- ---------------------
CONTINUING OPERATIONS
The following summarizes the results of continuing operations for the
years ended November 30, 1998, 1997 and 1996.
Statements of Operations
----------------------------------------------------------------------
$ in Thousands % of Revenue
------------------------------------ ------------------------------
(Pro forma) (Pro forma)
1998 1997 1996 1998 1997 1996
------------------------------------ ------------------------------
(unaudited) (unaudited)
Food and beverage revenue $27,044 $ 26,860 $26,406 100.0% 100.0% 100.0%
Costs and expenses
Cost of food and beverages 7,752 7,720 7,848 28.7 28.7 29.6
Operating expenses 15,647 15,857 15,595 57.8 59.0 59.1
General and administrative
Restaurant operations 1,420 1,362 1,149 5.3 5.1 4.4
Corporate level expenses 1,692 1,525 1,429 6.2 5.7 5.4
Depreciation and amortization 1,079 1,070 919 4.0 4.0 3.5
------- -------- ------- ----- ----- -----
Total costs and expenses 27,590 27,534 26,940 102.0 102.5 102.0
------- -------- ------- ----- ----- -----
Loss from operations (546) (674) (534) (2.0) (2.5) (2.0)
Other income (expense)
Interest expense (1,473) (1,440) (467) (5.5) (5.4) (1.8)
Interest income 185 593 658 0.7 2.2 2.4
Other income 509 -- -- 1.9 -- --
Loss on disposal of assets (25) (218) (25) (0.1) (0.8) (0.1)
Minority interest 26 (196) 21 0.1) (0.7) 0.1
------- -------- ------- ---- ---- ----
Total other income (expense) (778) (1,261) 187 (2.9) (4.7) 0.6
------- -------- ------- ----- ----- -----
Loss from continuing operations
before income taxes (1,324) (1,935) (374) (4.9) (7.2) (1.4)
Income taxes - current 50 -- -- 0.2 --
------- -------- ------- ----- ----- -----
Loss from continuing operations $(1,374) $ (1,935) $ (374) (5.1%) (7.2) (1.4%)
======= ======== ======= ===== ===== =====
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COMPARISON OF YEARS ENDED NOVEMBER 30, 1998 AND 1997
----------------------------------------------------
REVENUE
Sales increased 0.7% from $26,860,546 in fiscal 1997 to $27,043,954 in
fiscal 1998. Although sales increased only slightly for the year, sales on a per
restaurant basis of approximately $1,082,000 (i) approached sales levels of
Wendy's International's corporate owned restaurants which had average sales of
approximately $1,174,000 per restaurant in 1998, and (ii) compared favorably
with all Wendy's franchised restaurants which had average sales of approximately
$1,031,000 per restaurant in 1998.
Several product-related factors had a significant impact on the
Company's sales. In April 1997 the Company began phasing-out its hot SuperBar
offering, and in April 1998 the cold salad bars were removed from all the
restaurants. The termination of these two product offerings was carried out at
the direction of Wendy's International. Lost sales resulting from the closure of
these two all-you-can-eat food bar concepts totaled $959,000 in fiscal 1998
compared to fiscal 1997. This reduction in sales, however, was offset by a
number of actions taken by the Company including:
o The introduction of the "Pita" sandwich product in April 1997
which constituted 5.3% of total sales in 1998.
o The expansion of the Company's "Late Night" sales program from a
seasonal effort (typically beginning in April and ending in
September) to a year round sales program. Late night sales rose
nearly 100%, from approximately $473,000 in 1997 to approximately
$941,000 in 1998.
o Increased emphasis on Wendy's "Upsizing" program (the addition of
a larger beverage or french fried potatoes for an extra 39 cents)
which began in April 1997. Upsize sales rose in 1998 to
approximately $272,000 from approximately $185,000 in 1997, an
increase of 47%.
Sales in 1998 were also positively impacted by an overall increase in
"combo" sales (a specific menu offering which includes a sandwich, french fried
potatoes and a beverage) and relatively mild winter weather conditions during
the first quarter of fiscal 1998 and November 1998. Sales during fiscal 1998
were negatively impacted by intense competition throughout the quick-service
industry including price discounting. The Company and Wendy's International have
continued to resist engaging in deep price discounting, choosing instead to
combat low prices with "value menu" offerings and high quality, made-to-order
products. Weighted average price increases for fiscal 1998 were less than 1%
compared to fiscal 1997.
COST OF FOOD AND BEVERAGES
Cost of food and beverages increased $31,880 in fiscal 1998 compared to
fiscal 1997 (from $7,720,307 to $7,752,187), while revenue increased $183,408
for the same period. As a percentage of sales, cost of food and beverages was
28.7% for both fiscal 1998 and fiscal 1997. Beef prices have remained relatively
stable since late 1996 and poultry prices were relatively low during early and
mid- 1998. The elimination of the hot and cold SuperBar, which operated with
slightly higher than average food costs and waste, also contributed to steady
food costs. Stabilized management teams in the Company's restaurants, combined
with continued and consistent emphasis on food cost controls, contributed to
controlling waste and keeping the Company's cost of food and beverage percentage
in line with guidelines established by the Company and Wendy's International.
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OPERATING EXPENSES
Restaurant operating expenses decreased $209,395, from $15,856,833 in
fiscal 1997 to $15,647,438 in fiscal 1998. As a percentage of revenue,
restaurant operating expenses decreased 1.2 percentage points in fiscal 1998
compared to fiscal 1997 (from 59.0% of revenue in 1997 to 57.8% of revenue in
1998). Advertising expense declined 0.4 percentage points as a result of Wendy's
International entering into a national advertising contract with Coca-Cola USA,
which reduced the Company's mandatory advertising contribution to the Wendy's
International national advertising program during the fourth quarter of 1998.
Rent expense decreased 0.5 percentage points in fiscal 1998 compared to fiscal
1997. This decrease resulted from the elimination of rent expense during the
final four months of the year associated with five of the Company's restaurants
whose real estate was purchased by the Company on September 1, 1998. Slight
decreases in food serving supplies, utilities, and training costs also
contributed to the decline in restaurant operating expenses.
Payroll costs remained stable in fiscal 1998 compared to fiscal 1997
despite (i) the continued pressure to increase hourly rates caused by an
extremely tight labor market, and (ii) the additional store managers hired in
late fiscal 1998 in preparation of new restaurant openings in early fiscal 1999.
The stability in payroll expenses was primarily attributable to decreased store
management turnover. On a per restaurant basis, restaurant operating expenses
decreased from an average of approximately $634,000 per restaurant in fiscal
1997 to an average of approximately $626,000 per restaurant in fiscal 1998, a
decrease of 1.3% compared to the 0.7% increase in same store sales.
GENERAL AND ADMINISTRATIVE
Restaurant Operations
Restaurant general and administrative expenses increased $58,271 in
fiscal 1998 compared to fiscal 1997 (from $1,362,199 to $1,420,470). As a
percentage of revenue, general and administrative expenses increased from 5.1%
of revenue in fiscal 1997 to 5.3% of revenue in fiscal 1998. An increase in the
Michigan Single Business Tax of $80,000 (0.3 percentage points as a percentage
of revenue), recruiting costs (due to a shortage of managerial candidates), and
office expense were the primary reasons for this increase. These increases were
largely offset by a decrease in legal and professional fees of approximately
$115,000 (0.4 percentage points) in fiscal 1998 compared to fiscal 1997. Legal
and professional fees were unusually high in 1997 due to the former general
partner's attempts to sell, and the subsequent dissolution of, the former
Wendy's of West Michigan Limited Partnership.
Corporate Level Expenses
Corporate general and administrative expenses increased $166,747 in
fiscal 1998 compared to fiscal 1997 (from $1,524,693 to $1,691,440). The
increase in corporate general and administrative expenses was due to (i) an
increase in payroll costs of approximately $131,000 caused primarily by
severance costs associated with the discontinuance of the lodging business
segment which resulted in a reduction in executive level positions, and (ii) an
increase in legal fees of approximately $102,000 caused by the prolonged
litigation brought by the former general partner of the now dissolved Wendy's of
West Michigan Limited Partnership. These increases were offset by reductions in
accounting and other professional fees, office expense, public market expense,
promotional costs, and travel and entertainment.
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DEPRECIATION AND AMORTIZATION
Depreciation and amortization increased only slightly, from $1,070,017
in fiscal 1997 to $1,078,539 in fiscal 1998. As a percentage of sales,
depreciation was 4.0% in both fiscal 1998 and 1997.
INTEREST EXPENSE
Interest expense increased $32,827 in fiscal 1998 compared to fiscal
1997 (from $1,440,192 in fiscal 1997 to $1,473,019 in fiscal 1998). The increase
in interest expense was primarily due to interest expense incurred on additional
borrowings of $4,200,000 in September 1998 to acquire the real estate of five
restaurants which had previously been leased to the Company. See Item 7,
"Liquidity and Capital Resources" for a discussion of the Company's debt
restructuring.
INTEREST INCOME
Interest income decreased $408,236 in fiscal 1998 compared to fiscal
1997 (from $592,850 in fiscal 1997 to $184,614 in fiscal 1998). The decrease in
interest income was due to the non-recognition of any interest income in fiscal
1998 on the Company's note receivable from the sale of stock, compared to the
recognition of $564,929 of interest income in fiscal 1997. During the second
quarter of 1998, the Company determined that a valuation allowance was
appropriate due to the longer term price trend of the stock, which serves as
collateral for the note receivable. Because of the decrease in the value of the
collateral securing the note receivable, a valuation allowance of $4,666,755 has
been made to adjust the note receivable to its estimated realizable value if the
shares of common stock securing the note were sold and the proceeds were applied
to the note receivable. As detailed in the Company's Statement of Stockholders'
Equity, the valuation allowance has no net effect on the Company's total
stockholders' equity.
Interest income in fiscal 1998 includes interest income from the notes
receivable from the sale of the Company's hotel properties of $142,466, and
interest income from cash and cash equivalents of $42,148.
OTHER INCOME
Other income was $509,590 in fiscal 1998 compared to zero in fiscal
1997. Other income in 1998 consisted primarily of income from the forfeiture of
an earnest deposit in the amount of $500,000 on a contract to sell one of the
Company's hotel properties.
LOSS ON DISPOSAL OF ASSETS
In fiscal 1998, the Company incurred a loss on the disposal of assets
of $25,000 compared to a loss on disposal of assets of $197,102 in fiscal 1997.
The fiscal 1998 loss was the result of the write-off of the franchise fee
regarding a Wendy's restaurant that was closed in 1997 which was determined to
be non-transferable to a new store in fiscal 1998. The fiscal 1997 loss was due
to the closing of the same restaurant and the decision not to extend the lease
on the restaurant building.
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INCOME TAXES - CURRENT
In fiscal 1998, the Company incurred a current income tax expense and
current income tax liability of $50,000. Although no regular income tax
liability was incurred for fiscal 1998 because of the use of net operating loss
carryforwards, for alternative minimum tax purposes, the amount of alternative
tax net operating loss deduction is limited to 90% of alternative minimum
taxable income. This limitation resulted in fiscal year 1998 alternative minimum
tax of $50,000.
COMPARISON OF YEARS ENDED NOVEMBER 30, 1997 AND 1996
----------------------------------------------------
REVENUE
Sales increased 1.0% from $26,405,513 in fiscal 1996 to $26,860,546 in
fiscal 1997. Excluding the restaurant that was opened in March 1996 and the
restaurant that was closed in August 1997, sales on a per restaurant basis for
the Company's twenty-four restaurants in operation during the entire twelve
months of both fiscal 1997 and fiscal 1996 increased 1.1%, from an average of
$1,052,485 per restaurant in fiscal 1996 to $1,064,558 per restaurant in fiscal
1997. Although sales increased only slightly for the year, sales (i) were
comparable to the sales of Wendy's International's corporate owned restaurants
which had average sales of approximately $1,110,000 per restaurant in 1997, and
(ii) compared favorably with all Wendy's franchised restaurants which had
average sales of approximately $1,002,000 per restaurant in 1997.
COST OF FOOD AND BEVERAGES
Cost of food and beverages decreased $127,782 in fiscal 1997 compared
to fiscal 1996, while revenue increased $455,033 for the same period. This
decrease was the result of a 0.9 percentage point decrease in the Company's food
and beverage cost percentage (from 29.6% of revenue in fiscal 1996 to 28.7% of
revenue in fiscal 1997). The decrease in the Company's cost of food and beverage
percentage was primarily the result of relatively stable food costs throughout
fiscal 1997, and effective cost controls combined with the closing of the hot
SuperBars which had a higher food cost than its menu replacement (i.e. Pita
sandwiches).
OPERATING EXPENSES
As a percentage of revenue, restaurant operating expenses were 59.0% in
fiscal 1997, and 59.1% in fiscal 1996. Increases in payroll costs of
approximately 0.7 percentage points and increased repair and maintenance costs
were offset by decreases in advertising and insurance expenses. On a per
restaurant basis, restaurant operating expenses increased from an average of
approximately $624,000 per restaurant in fiscal 1996 to an average of
approximately $634,000 per restaurant in fiscal 1997, an increase of 1.6% which
is comparable to the 1.1% increase in same store sales.
-16-
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GENERAL AND ADMINISTRATIVE
Restaurant Operations
Restaurant general and administrative expenses increased $212,881 in
fiscal 1997 compared to fiscal 1996 (from $1,149,318 to $1,362,199). As a
percentage of revenue, general and administrative expenses increased from 4.4%
of revenue in fiscal 1996 to 5.1% of revenue in fiscal 1997. An increase in the
Michigan Single Business Tax of $117,218 (0.4 percentage points as a percentage
of revenue) was the primary reason for this increase. The Michigan Single
Business Tax for fiscal 1996 was abnormally low due to a partial refund of taxes
paid in four previous years. Increases in administrative salaries, recruiting
costs and a significant increase in professional fees accounted for the
remaining increase.
Corporate Level Expenses
General and administrative expenses increased $96,493 (6.8%), from
$1,428,200 in fiscal 1996 to $1,524,693 in fiscal 1997. The increase in general
and administrative expenses in fiscal 1997 compared to fiscal 1996 was partially
due to approximately $372,000 of personnel costs in fiscal 1997 associated with
adding executive level positions and making market related salary adjustments.
This increase was offset by a decrease of approximately $272,000 in
non-recurring legal fees, professional fees and travel related costs which were
incurred in 1996 in connection with the replacement and restructuring of the
Company's management.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense increased $151,361 (16.5%), from
$918,656 in fiscal 1996 to $1,070,017 in fiscal 1997. The increase in
depreciation and amortization expense was primarily due to the adjustment to
fair value of the property and equipment acquired in connection with the
acquisition of a majority of the former Wendy's of West Michigan Limited
Partnership on October 31, 1996, and the resulting goodwill from the excess of
the acquisition cost over the fair value of the net assets acquired.
INTEREST EXPENSE
Interest expense increased from approximately $467,000 in fiscal 1996
to approximately $1,440,000 in fiscal 1997. The significant increase in interest
expense was primarily due to interest expense incurred on $6,000,000 of
acquisition related financing.
INTEREST INCOME
Interest income decreased from $658,007 in fiscal 1996 to $592,850 in
fiscal 1997. The decrease in interest income was due to a decrease in cash and
cash equivalents during fiscal 1997. The decrease was also attributable to the
reduction in note receivable interest income due to the reduction in the note
receivable as a result of a $750,000 principal prepayment received in May 1996.
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LOSS ON DISPOSAL OF ASSETS
The loss on disposal of assets was primarily attributable to the
closing of one of the Company's restaurants due to its continuing operating
losses. As a result of this restaurant closing, and the Company's decision not
to exercise the option to extend the lease of the restaurant building, the
Company incurred a loss on disposal of assets of $197,102.
DISCONTINUED OPERATIONS - LODGING GROUP
During the second quarter of 1998, the Company entered into agreements
to sell its remaining two hotel properties (see Item 1, "Sale of Hotel
Properties"). This resulted in the Company accounting for its lodging business
segment as a discontinued operation as of May 31, 1998. Below is a summary of
the lodging group's operating results for the years ended November 30, 1998,
1997 and 1996, as well as a summary of the sale transactions for all three of
the Company's hotel properties:
RESULTS OF OPERATIONS
---------------------
FOR THE YEARS ENDED NOVEMBER 30,
--------------------------------
1998 1997 1996
---- ---- ----
Revenues $6,358,126 $14,034,053 $ 14,762,822
Costs and expenses 6,206,192 13,555,900 15,469,298
---------- ----------- ------------
Earnings (loss) from operations 151,934 478,153 (706,476)
Other expense (791,166) (1,550,721) (1,506,778)
---------- ----------- ------------
Loss from discontinued operations
before federal income taxes $ (639,232) $(1,072,568) $(2,213,254)
========== =========== ===========
A summary of the three sale transactions is as follows:
Grand Harbor
Resort
Thomas Edison Inn & Yacht Club St. Clair Inn
----------------- ------------ -------------
Date of sale September 1, 1998 June 15, 1998 November 30, 1997
Selling price (before selling costs) $12,200,000 $4,500,000 $3,800,000
Promissory note held by Company 2,000,000 1,375,000 --
----------- ---------- ----------
Cash portion of selling price $10,200,000 $3,125,000 $3,800,000
=========== ========== ==========
Gain on sale of assets $ 3,273,893 $ 583,164 $1,479,095
Loss from operations from measure-
ment date (May 31, 1998) to date
of disposal 109,800 35,893 --
----------- ---------- ----------
Gain on disposal of discontinued
operations 3,164,093 547,271 1,479,095
Extraordinary charges (includes
loan prepayment penalty and
write-off of deferred finance costs) 548,395 178,777 177,291
----------- ---------- ----------
Impact on equity $ 2,615,698 $ 368,494 $1,301,804
=========== ========== ==========
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19
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Cash Flows - Year Ended November 30, 1998
Cash and cash equivalents ("cash") increased $1,047,883, from
$1,061,475 as of November 30, 1997 to $2,109,358 as of November 30, 1998. The
increase in cash was the result of the following:
Net cash provided by operating activities $ 3,296,484
Net cash used in investing activities (5,847,106)
Net cash provided by financing activities 3,598,505
-----------
Net increase in cash $ 1,047,883
===========
Net cash provided by operating activities of $3,296,484 was comprised
of $687,355 net cash used in continuing operations, and $3,983,839 net cash
provided by discontinued operations. The cash used in continuing operations was
a combination of (i) the net loss from continuing operations before
depreciation, amortization, extraordinary item and non-cash portion of income
taxes totaling $271,396, and (ii) a $3,219,617 increase in the note receivable
from sale of assets. These cash effects were offset by (i) $1,992,026 of
marketing and conversion funds received from the Company's beverage supplier
upon the Company entering into a long-term agreement to purchase its beverage
products solely from this supplier (the advance has been accounted for as
deferred revenue - see Note K of the Company's Financial Statements), and (ii)
other non-cash effects on net income and net cash provided by operating
activities (primarily a net increase in current assets and liabilities) totaling
$811,632. The net cash provided by discontinued operations is comprised of net
income from discontinued operations net of the extraordinary item of $2,549,998,
combined with a decrease in net assets of $1,433,841.
Net cash used in investing activities of $5,847,106 was the result of
cash purchases of property, plant and equipment of $5,029,283, which includes a
$4,200,000 purchase of the real estate associated with five Wendy's restaurants
previously leased, and a payment of $758,632 in the acquisition of the general
partner interest of the former Wendy's of West Michigan Limited Partnership.
Increases in other assets accounted for the remaining $59,191.
Net cash provided by financing activities of $3,598,505 was the result
of proceeds of long-term debt and notes payable of $11,907,151. This was offset
by principal payments of long-term debt and payments of capital lease
obligations totaling $7,940,733, of which approximately $6.6 million represented
payments related to debt restructure (discussed below), and approximately $1.3
million represented scheduled debt payments. The long-term debt proceeds were
also offset by the payment of financing costs of $265,129, and preferred
dividend payments less proceeds from the issuance of common shares totaling
$102,784.
The Company was involved in two non-cash investing and financing
activities during the year. The transactions included (i) the issuance of
1,992,359 common shares in connection with the acquisition of the Wendy's
operations, and (ii) the assignment of the $1,375,000 note receivable described
in Note E of the Financial Statements in exchange for, among other things, the
cancellation of a $776,000 note payable and the cancellation of 20,000
convertible preferred shares. The $1,375,000 note was assigned with recourse
and, therefore, the Company would be required to pay, upon completion of its
collection efforts, the amounts due the assignee to the extent payments are not
made on the note by the original maker.
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Cash Flows - Year Ended November 30, 1997 (Restated)
Cash decreased $1,204,022 from $2,265,497 as of November 30, 1996, to
$1,061,475 as of November 30, 1997. The decrease in cash was the result of the
following:
Net cash used in operating activities $ (851,216)
Net cash used in investing activities (811,703)
Net cash provided by financing activities 458,897
-----------
Net decrease in cash $(1,204,022)
===========
Net cash used in operating activities of $851,216 was comprised of
$522,177 from continuing operations and $329,039 from discontinued operations.
The $522,177 net cash used in continuing operations was primarily due to the net
loss before depreciation and amortization of $669,430, which was offset by (i)
other non-cash effects on net income and net cash used in operating activities
totaling $131,682, and (ii) the net change in current assets and current
liabilities of $15,571. The net cash used in discontinued operations of $329,039
was the result of net income after extraordinary item of $244,236 offset by an
increase in net assets of $573,275.
Net cash used in investing activities of $811,703 was primarily the
result of purchases of property, plant and equipment of $608,071, and the
investment of $182,526 in acquisition of the Wendy's operations. The remaining
$21,106 was the result of an increase in other assets.
Net cash provided by financing activities of $458,897 was primarily the
result of net proceeds from long-term borrowings of $750,000 and the issuance of
preferred and common shares totaling $313,519. These two items were offset by
the payment of long-term debt, including capital leases, of $502,908. The
remaining $101,714 represented dividends paid on preferred stock.
Financial Condition
At November 30, 1998, the Company's current assets exceeded its current
liabilities by $230,420 compared to November 30, 1997 when current liabilities
exceeded current assets by $1,466,684. At these dates, the ratios of current
assets to current liabilities were 1.05:1 and .53:1, respectively. The
discussion above regarding cash flows for the year ended November 30, 1998
explains the increase in cash as well as the most significant reasons for the
increase in working capital. The other primary reason for the improvement in
working capital was the $1,619,617 net increase in the current portion of the
notes receivable from the sale of assets.
As of November 30, 1998, the Company's long-term debt consisted
primarily of the following:
o $8,658,644 mortgage notes payable requiring monthly payments of
$72,372, including interest at rates ranging from 7.77% to 8.15%
through September and October 2018.
o $1,113,588 notes payable requiring monthly payments of $10,802
including interest at 8.15% through September 1, 2018.
o $310,717 construction note payable requiring monthly payments of
interest only at 7.27% through the completion of the building
construction, at which time a permanent mortgage note will be
secured.
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21
o $1,375,000 obligation arising from the $1,375,000 note receivable
from the sale of the Grand Harbor Resort & Yacht Club, which note
receivable was assigned with recourse to the Chairman of the
Board as part of separate transaction. (See Item 1, "Other
Assets" and Item 7, "Liquidity and Capital Resources" at page
19). Due to the recourse nature of the obligation, it is
accounted for as long-term debt in the Financial Statements, and
is described as an "amount payable" in Note H of the Financial
Statements. The note receivable is described in Note E to the
Financial Statements. Because the obligation was assigned with
recourse, to the extent the note receivable is not paid by the
maker, the Company would be required to make payment to the
assignee upon completion of its collection efforts.
o $365,455 equipment notes payable requiring monthly payments of
$19,416, including interest at rates ranging from 7.5% to 10%.
The various loan agreements contain loan covenants requiring the
maintenance of certain financial ratios including:
o Fixed Charge Coverage Ratio ("FCCR") of 1.2 : 1 for the Wendy's
operation as a whole;
o FCCR of 1.2 : 1 for the Wendy's restaurants that are subject to a
real estate mortgage;
o FCCR of 1.4 : 1 for the Wendy's restaurants that are subject to
both a real estate mortgage and a business value loan; and
o a restriction against using operating cash flow from the Wendy's
business to fund corporate level expenses if such funding would
cause the FCCR to be less than 1.2 : 1.
At November 30, 1998, the Company was in compliance with these covenants.
During the past fiscal year the Company completed several significant
transactions resulting in improved cash flow. These include:
1) the sale of three hotel properties which operated at a $372,000
negative cash flow after debt service and normal capital
expenditures in fiscal 1997;
2) the retirement or restructuring of high interest rate long-term
debt, resulting in:
o the reduction in the current weighted average interest rate
on long-term debt from 12.4% as of November 30, 1997 to
8.2%, and
o the reduction in annualized interest expense by
approximately $385,000;
3) the conversion of preferred stock to common stock, thereby reducing
the annual dividend payments by $66,500; and
4) the acquisition of the remaining Wendy's operations which generated
cash flow after debt service and normal capital expenditures (net
of debt acquired) of approximately $908,000 in fiscal 1998.
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22
The completion of these transactions significantly strengthened the Company's
cash flow position.
The cash flow management issues currently facing the Company can be
broken down into three areas: (i) operations of the Wendy's restaurants, (ii)
corporate level expenses, and (iii) investment in new restaurants.
The key issues involved in cash flow management for the Wendy's
operations include a seasonal cash flow tightening during the first quarter of
the fiscal year. The Company typically experiences negative operating cash flow
during this quarter due to lower sales volume and the payment of the real estate
and equipment property taxes in February. Fiscal 1999 presents a particularly
difficult challenge as the Company is funding certain pre-opening costs
associated with the opening of two new restaurants in February and March 1999.
The Company also anticipates needing short-term working capital to fund
pre-opening costs for three other restaurants during the year. The Company
estimates capital expenditures for the next twelve months at its existing
Wendy's restaurants to be approximately $500,000 for building improvements and
furniture, fixtures and equipment purchases.
The Company's loan agreements restrict the amount of currently
generated operating cash flow from the Wendy's restaurants that may be utilized
to fund corporate level expenses. The Company anticipates that the corporate
level expenses will be funded primarily with cash flow from the Wendy's
operation in accordance with the loan covenants, as well as from cash proceeds
generated from non-operating activities. These activities include the sale of
life insurance policies, investment interest income, and the collection of
certain notes receivable. Corporate level expense in fiscal 1999 is expected to
be significantly lower than in fiscal 1998. The Company began implementing a
number of significant general and administrative cost cutting measures to
achieve these cost reductions. However, there can no assurance that the Company
will be able to fully achieve its planned cost reductions, either as to dollar
amount or timing of the cost cutting measures.
The Company estimates that an investment of approximately $3,025,000
will be made into the real estate of three new Wendy's restaurants, and that
operating leases will be secured on the real estate for two other new
restaurants during the upcoming fiscal year. The Company has received a forward
commitment and other proposals to fund the real estate at interest rates
currently ranging from 7% - 9%. The Company anticipates financing 90 - 100% of
the cost of the real estate through the use of external financing. Additionally,
the Company estimates that an investment of $1,375,000 will be required for
equipment packages and franchise fees associated with opening five new Wendy's
restaurants during the upcoming fiscal year. It is anticipated that $500,000 of
this equipment investment will be funded through the use of external financing.
The Company has received multiple equipment leasing proposals at terms of five
to seven years with interest rates of approximately 8%.
Currently, the Company has committed to financing two new Wendy's
restaurants with mortgage notes that total $1,940,000, of which $1,250,215 has
been borrowed as of February 1999. The 20-year mortgages will carry a fixed
interest rate equal to 2.75% over the then current 10-year treasury rate on the
date of completion of construction on the restaurants (expected to occur in
February and March 1999). Based on current treasury rates, the rate would be
approximately 7.75%.
In light of these operational and investment cash flow management
challenges, the Company plans to meet its current obligations over the next
twelve months by:
o Utilizing cash reserves in excess of $1,000,000.
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23
o Using $900,000 of projected operating cash generated from
existing Wendy's restaurants.
o Selling life insurance policies for net proceeds of approximately
$200,000.
o Exploring the acquisition of a working capital line of credit.
o Collecting on the Company's notes receivable which are expected
to produce net proceeds of approximately $740,000.
o Exploring the financing of certain of the planned capital
expenditures and improvement as opposed to paying cash,
specifically with respect to planned renovations at the Wendy's
restaurants.
o Exploring the financing of equipment packages for certain of the
new restaurants as opposed to making a cash investment.
o Reducing or deferring the capital expenditures described above.
There can be no assurances, however, that the Company will be able to
complete the above activities or that completion would yield the results
expected. Also, notes receivable described in Note E of the Financial Statements
totaling $3,219,617 have been assigned with recourse. To the extent those notes
are not paid by their makers, the Company would be obligated to make the
payments to the assignees upon completion of its collection efforts. Collection
efforts would include attempts to foreclose on collateral that is described in
Note E. Although the Company believes that the collateral is sufficient to cover
the remaining obligations on those notes, there is no assurance that the Company
would be able to effect such a realization when payments on the notes would
ultimately be due to the assignees, and no assurances that the amounts recovered
would be sufficient to cover amounts due those assignees. In such circumstances,
the Company would be required to secure necessary funds through borrowings or
other means.
INFLATION AND CHANGING PRICES
- -----------------------------
The food service industry has been affected by the increase in the
minimum wage and the shortage of management and hourly employees. Rising wage
rates had a negative impact on the Company's operating results in fiscal 1998.
Increases in labor costs, along with periodic increases in food and other
operating expenses, are normally passed on to customers in the form of price
increases. However, highly competitive market conditions have minimized the
Company's ability to offset higher costs through price increases to its
customers.
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COMPUTER SYSTEMS - YEAR 2000 IMPACT
- -----------------------------------
The Company and its vendors have become increasingly reliant on
computer systems to process transactions and to provide relevant business
information. The majority of computer systems designed prior to the mid-1990's
are susceptible to a well publicized problem associated with an inability to
process date related information beginning with the year 2000. Almost all of the
Company's computer hardware was acquired within the past three years. The
Company is completing its review of its computer hardware and software with the
assistance of the software designers to ensure that all significant software
applications are year 2000 compliant. Based on the results of the review to
date, the Company believes that the point-of-sale system, which monitors all
sales, inventory and labor activity, is year 2000 compliant. The critical
systems which are used to produce financial statements (general ledger module)
and process purchases and cash disbursements (accounts payable module) have also
been tested and are year 2000 compliant. However, the Company's software used to
process payroll and compare actual product usage with planned product usage are
not yet year 2000 compliant. The Company software vendor has assured the Company
that the payroll software will be year 2000 compliant by the end of the first
calendar quarter of 1999. The Company plans to replace its product usage
software with software that is year 2000 compliant.
The Company has estimated that necessary replacement or modification of
its hardware and software could cost from $75,000 to $150,000. However, the
Company can make no assurance that all year 2000 risks to the Company and to its
critical vendor systems can be identified and successfully negated through
modification or replacement of existing programs. The Company does not expect to
incur significant additional costs to complete the review of its computer
systems to determine what measures are required to be year 2000 compliant.
Pending the final results of this review, the Company cannot determine the exact
cost that may be required to ensure that all the critical computer systems are
year 2000 compliant.
Despite assurances from its various software vendors, the Company could
find that its critical computer systems are not year 2000 compliant or that it
experiences computer equipment failures. In such event, the Company's
contingency plan includes the following:
1) Point-of-Sale System - The Company would immediately begin to
manually (i) process its sales, (ii) monitor its inventory, and
(iii) record its labor expense. This manual system would remain
in effect until such time as the year 2000 issues are corrected
or a substitute computerized system is installed. It is
possible, however, that if the year 2000 issues can not be
corrected, or a substitute system cannot be installed within a
short period of time, the Company's operations could be adversely
affected.
2) Financial Statements, Cash Disbursements and Payroll Systems -
The Company would initiate one or more of the following
contingency plans until the year 2000 issue can be corrected: (i)
manual processing, (ii) utilization of an alternative software
program on a "stop-gap" basis until the system can be corrected,
or (iii) contract with a third party vendor to process payments,
payroll and financial statements.
NEW PRONOUNCEMENTS
- ------------------
In June 1997, the Financial Accounting Standards Board (FASB) issued
FSAS No. 130, "Reporting of Comprehensive Income," which establishes standards
for reporting and display of comprehensive income and its components (revenues,
expenses, gains and losses) in a full set of financial statements. This
statement also requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. This statement is effective for fiscal years beginning
after December 15, 1997. Reclassification of financial statements for earlier
periods provided for comparative purposes is required. The Company does not
anticipate that adoption of SFAS No. 130 will have any effect on its financial
statements.
-24-
25
MANAGEMENT'S OUTLOOK
- --------------------
The Company began implementation of an aggressive new store development
plan for fiscal 1999. Two restaurants that are currently under construction are
scheduled to open in February and March 1999. The Company plans to open or have
under construction an additional three to five restaurants by the end of fiscal
1999. This rapid new store development will challenge the Company to maintain
its profit margins as new restaurants require higher than normal training and
development of personnel. Food usage may also be higher than normal during the
early stages of a new restaurant opening as store management teams tend to
over-estimate product needs to ensure customer satisfaction. The Company has
increased the number of restaurant supervisory personnel in anticipation of the
planned new store openings in fiscal 1999. Included in the new restaurant
development plans is the expectation that one or two of the new restaurants will
be a combination restaurant/gas and convenience store unit. This concept, known
as co-branding, is becoming common in the quick-service restaurant industry.
Wendy's International estimates that approximately 20% of their system-wide new
restaurants in 1999 will be combination restaurant/gas and convenience store
units. The Company is presently involved in negotiations with a number of gas
and convenience store operators concerning its own co-branding project.
The Company is projecting same-store sales increases for fiscal 1999 of
3% over fiscal 1998. Sales for the fourth quarter of fiscal 1998 through the
week ended February 14, 1999 are up approximately 6% over the same period of the
prior year. In an effort to improve customer service and sales volumes, Wendy's
International is embarking on a program throughout the Wendy's system called
"Service Excellence." This program is designed to speed pick-up window service
and to enhance the customer's dining experience. The Company will engage in this
program which, depending on the identified requirements of the program, may
require capital expenditures ranging from $1,000 to $15,000 per restaurant.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements and supplementary data included in the report
under this Item are set forth at the end of this report beginning on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
Items 10, 11, 12 and 13 of Part III are incorporated by reference to
the Registrant's Proxy Statement for its 1999 Annual Shareholders' Meeting to be
filed with the Commission pursuant to Regulation 14A.
-25-
26
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1) and (2) Financial Statements and Schedules.
-----------------------------------
All financial statements and schedules required to be filed by Item 8
of this Form and included in this report are set forth at the end of this report
beginning on page F-1. No additional financial statements or schedules are being
filed since the requirements of paragraph (d) under Item 14 are not applicable
to the Company.
(a)(3) Exhibit List.
-------------
The following documents are exhibits to this Annual Report:
Exhibit No. Description of Document
- ----------- --------------------------------------------------------------
3.1 Amended and Restated Articles of Incorporation (1).
3.2 Restated and Amended Bylaws (10).
4.1 Certificate of Designation of Series A Convertible Preferred
Shares (3).
4.2 Subscription Agreement relating to issuance of Series A
Convertible Preferred Shares (3).
10.1 First Amended & Restated Secured Promissory Note and Stock
Pledge Agreement by and between the Company and CBH Capital
Corp. (4).
10.2 Second Amended & Restated Secured Promissory Note and Stock
Pledge Agreement by and between the Company and CBH Capital
Corp. (2).
10.3 Loan Agreement dated November 26, 1996 among Meritage
Hospitality Group Inc., St. Clair Inn, Inc., Grand Harbor
Resort Inc., Thomas Edison Inn, Incorporated, MHG Food Service
Inc. and Grand Harbor Yacht Club Inc., as obligors, and Great
American Life Insurance Company, as lender (3).
10.4 Promissory Note dated November 26, 1996 by St. Clair Inn,
Inc., Grand Harbor Resort Inc., and Thomas Edison Inn,
Incorporated, as makers, and Great American Life Insurance
Company, as payee (paid in full on 10/4/98) (3).
10.5 Promissory Note dated November 26, 1996 by Meritage
Hospitality Group Inc., MHG Food Service Inc. and Grand Harbor
Yacht Club Inc., as makers, and Great American Life Insurance
Company, as payee (paid in full on 10/6/98) (3).
10.6 Amendment No. 1 to Loan Agreement dated November 26, 1996
among Meritage Hospitality Group Inc., St. Clair Inn, Inc.,
Grand Harbor Resort Inc., Thomas Edison Inn, Incorporated, MHG
Food Service Inc. and Grand Harbor Yacht Club Inc., as
obligors, and Great American Life Insurance Company, as lender
(5).
-26-
27
10.7 Promissory Note dated May 23, 1997 by Grand Harbor Yacht Club
Inc., as maker, and Great American Life Insurance Company, as
payee (paid in full on 10/4/98) (5).
10.8 Waiver, Second Amendment and Modification Agreement dated
September 30, 1997 to the Loan Agreement dated November 26,
1996 among Meritage Hospitality Group Inc., St. Clair Inn,
Inc., Grand Harbor Resort Inc., Thomas Edison Inn,
Incorporated, MHG Food Service Inc. and Grand Harbor Yacht
Club Inc., as obligors, and Great American Life Insurance
Company, as lender (6).
10.9 Waiver, Third Amendment and Modification Agreement to Loan
Agreement dated November 26, 1996 among Meritage Hospitality
Group Inc., SC Inn Inc., GHR Inc., Thomas Edison Inn,
Incorporated, MHG Food Service Inc., GHYC Inc., as obligors,
and Great American Life Insurance Company, as lender (1).
10.10 Business Loan Agreement dated February 22, 1995 between
Wendy's of West Michigan Limited Partnership and First of
America Bank-Michigan, N.A. (paid in full on 9/1/98) (7).
10.11 Promissory Note dated February 22, 1995 by Wendy's of West
Michigan Limited Partnership, as maker, and First of America
Bank-Michigan, N.A., as payee (paid in full on 9/1/98) (7).
10.12 Sample Construction Loan Agreement with Captec Financial
Group, Inc. (1).
10.13 Sample Promissory Note with Captec Financial Group, Inc.
regarding real estate financing (1).
10.14 Sample Mortgage with Captec Financial Group, Inc. regarding
real estate financing (1).
10.15 Sample Promissory Note with Captec Financial Group, Inc.
regarding leasehold financing (1).
10.16 Sample Mortgage with Captec Financial Group, Inc. regarding
leasehold financing (1).
10.17 Sample Promissory Note with Captec Financial Group, Inc.
regarding business value financing (1).
10.18 Sample Security Agreement with Captec Financial Group, Inc.
regarding business value financing (1).
10.19 Promissory Note dated June 16, 1998 among Meritage Hospitality
Group Inc., as lender, and S.C. Land Acquisitions, L.L.C., as
borrower (8).
10.20 Promissory Note dated September 1, 1998 among Meritage
Hospitality Group Inc., as lender, and Reynolds/Ehinger
Enterprises, LLC, as borrower (9).
-27-
28
10.21 Consent Agreement dated May 16, 1997 between Wendy's
International, Inc., Wendy's of Michigan, Meritage Hospitality
Group Inc., MHG Food Service Inc., Meritage Capital Corp., MCC
Food Service Inc., Robert E. Schermer, Jr. and Christopher B.
Hewett, with sample Unit Franchise Agreement, Guaranties, and
Release of Claims attached as exhibits (5).
10.22 Agreement and Consent dated August 7, 1998 between WM Limited
Partnership - 1998, Meritage Hospitality Group Inc., MHG Food
Service Inc., Meritage Capital Corp., MCC Food Service Inc.,
Robert E. Schermer, Jr., and Christopher B. Hewett. (1).
10.23 Agreement and Consent dated December 16, 1998 between WM
Limited Partnership - 1998, Meritage Hospitality Group Inc.,
MHG Food Service Inc., Meritage Capital Corp., MCC Food
Service Inc., S & Q Management, LLC, Robert E. Schermer, Jr.,
Christopher B. Hewett, and Ray E. Quada. (10).
10.24 Agreement dated October 1, 1998 by and between Robert E.
Schermer, Sr. and the Company regarding sale of $1,375,000
promissory note (1).
10.25 Sample Loan Participation and Agency Agreement regarding sale
of participation interests in the Promissory Note dated
September 1, 1998 among Meritage Hospitality Group Inc., as
lender, and Reynolds/Ehinger Enterprises, LLC, as borrower.
(10).
10.26 Sample indemnification agreement for officers and directors of
the Company (11).
10.27 Settlement Agreement dated February 8, 1998 among Meritage
Hospitality Group Inc., CBH Capital Corp. and Christopher B.
Hewett with Option Agreement, Voting Agreement and Irrevocable
Proxy attached as exhibits (2).
MANAGEMENT COMPENSATORY CONTRACTS
10.28 Amended 1996 Management Equity Incentive Plan (12).
10.29 Amended 1996 Directors' Share Option Plan (5).
10.30 1999 Directors' Share Option Plan (10).
10.31 Directors' Compensation Plan (13).
10.32 Employee Share Purchase Plan (13).
----------------------------------
21 Subsidiaries of the Registrant (10).
23 Consent of Grant Thornton LLP (10).
27.1 Financial Data Schedule - Fiscal Year 1998 (10).
-28-
29
27.2 Financial Data Schedule - Fiscal Year 1997 (Restated) (10).
27.3 Financial Data Schedule - Fiscal Year 1996 (Restated) (10).
Exhibits previously filed and incorporated by reference from:
(1) The Quarterly Report on Form 10-Q for the Company's fiscal quarter
ended August 31, 1998.
(2) Amendment No. 12 to Schedule 13-D filed by Christopher B. Hewett and
CBH Capital Corp. on February 17, 1999.
(3) The Annual Report on Form 10-K for the Company's fiscal year ended
November 30, 1996.
(4) The Quarterly Report on Form 10-QSB for the Company's fiscal quarter
ended May 31, 1996.
(5) The Quarterly Report on Form 10-Q for the Company's fiscal year ended
May 31, 1997.
(6) Amendment No. 2 to the Registration Statement No. 333-33461 on Form S-4
filed with the Securities and Exchange Commission by the Company on
November 12, 1997.
(7) The Annual Report on Form 10-K for Wendy's of West Michigan Limited
Partnership for the fiscal year ended December 31, 1994.
(8) The Report on Form 8-K for the Company filed on June 18, 1998.
(9) The Report on Form 8-K for the Company filed on September 9, 1998.
(10) Filed herewith.
(11) The Annual Report on Form 10-K for the Company's fiscal year ended
November 30, 1997.
(12) The Quarterly Report on Form 10-Q for the Company's fiscal year ended
May 31, 1998.
(13) Registration Statement No. 333-06657 on Form S-8 filed with the
Securities and Exchange Commission by the Company on June 24, 1996.
(b) Reports on Form 8-K.
--------------------
On November 12, 1998, the Company filed Amendment No. 1 to the Form 8-K
originally filed on September 9, 1998 which reported that the Company's
wholly-owned subsidiary sold certain real and personal property, including the
Thomas Edison Inn located in Port Huron, Michigan, for $12,200,000. The
Amendment included pro forma consolidated financial statements regarding the
sale.
After its acquisition of the Wendy's business, the Company used two
accounting firms to perform the annual audit of financial statements. Grant
Thornton LLP had been the retained to perform the annual audit of the financial
statements for the Company and its wholly-owned subsidiaries since 1993. BDO
Seidman, LLP had been previously retained to perform the annual audit of the
financial statements for Wendy's business which the Company fully acquired in
January 1998. On November 12, 1998, the Company filed a report on Form 8-K which
reported that the Company determined it was most efficient to use one accounting
firm to perform the annual audit. Accordingly, on November 4, 1998, BDO Seidman,
LLP was dismissed (effective August 31, 1998), and the Company formally retained
Grant Thornton LLP to perform all aspects of the annual audit of the financial
statements for the Company and its subsidiaries.
On November 20, 1998, the Company filed Amendment No. 1 to the Form 8-K
originally filed on November 12, 1998 which reported that on November 4, 1998,
BDO Seidman, LLP was dismissed (effective August 31, 1998), and the Company
formally retained Grant Thornton LLP to perform all aspects of the annual audit
of the financial statements for the Company and its subsidiaries. The amendment
was filed to clarify that during the fiscal years ended November 30, 1996 and
1997, and through November 4, 1998, there were no disagreements with BDO
Seidman, LLP on any matter of accounting principles or practices, financial
statement disclosure, auditing scope or procedure, or any reportable events. BDO
Seidman, LLP's reports on the financial statements of the Wendy's business for
fiscal years ended November 30, 1996 and 1997 contained no adverse opinion or
disclaimer of opinion, and were not qualified or modified as to uncertainty,
audit scope or accounting principles.
-29-
30
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MERITAGE HOSPITALITY GROUP INC.
Dated: February 16, 1999 By /s/ Robert E. Schermer, Jr.
----------------------------
Robert E. Schermer, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Robert E. Schermer, Sr. Chairman of the Board of Directors February 16, 1999
- ------------------------------------
Robert E. Schermer, Sr.
/s/ Robert E. Schermer, Jr. President, Chief Executive Officer and February 16, 1999
- ------------------------------------ Director (Principal Executive Officer)
Robert E. Schermer, Jr.
/s/ Pauline M. Krywanski Vice President, Treasurer and Chief February 16, 1999
- ------------------------------------ Financial Officer (Principal Financial
Pauline M. Krywanski & Accounting Officer)
/s/ James P. Bishop Director February 16, 1999
- ------------------------------------
James P. Bishop
/s/ Christopher P. Hendy Director February 16, 1999
- ------------------------------------
Christopher P. Hendy
/s/ Joseph L. Maggini Director February 16, 1999
- ------------------------------------
Joseph L. Maggini
/s/ Jerry L. Ruyan Director February 16, 1999
- ------------------------------------
Jerry L. Ruyan
-30-
31
INDEX TO FINANCIAL STATEMENTS
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES Page
----
Report of Independent Certified Public Accountants ..........................M-1
FINANCIAL STATEMENTS
Consolidated Balance Sheets..................................................M-2
Consolidated Statements of Operations........................................M-4
Consolidated Statements of Stockholders' Equity..............................M-6
Consolidated Statements of Cash Flows........................................M-8
Notes to Consolidated Financial Statements .................................M-11
SCHEDULES
Schedule I Condensed Financial Information of Registrant....................M-28
Schedule II Valuation and Qualifying Accounts ..............................M-31
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP Page
----
Independent Auditors' Report ................................................W-1
FINANCIAL STATEMENTS
Balance Sheets...............................................................W-2
Statements of Income.........................................................W-4
Statements of Changes in Partners' Equity....................................W-6
Statements of Cash Flows.....................................................W-7
Notes to Financial Statements ...............................................W-9
F-1
32
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Meritage Hospitality Group Inc.
We have audited the accompanying consolidated balance sheets of Meritage
Hospitality Group Inc. (a Michigan corporation) and subsidiaries as of November
30, 1998 and 1997, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended November 30, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits. We did not audit the financial
statements of Wendy's of West Michigan Limited Partnership, a majority owned
subsidiary, which statements reflect total assets and revenues constituting 29
percent and 65 percent, respectively, of the related consolidated totals for
November 30, 1997. Those statements were audited by other auditors, whose report
thereon has been furnished to us and our opinion, insofar as it relates to the
amounts included for Wendy's of West Michigan Limited Partnership, is based
solely on the report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Meritage Hospitality Group Inc. and
subsidiaries as of November 30, 1998 and 1997 and the consolidated results of
their operations and their consolidated cash flows for each of the three years
in the period ended November 30, 1998, in conformity with generally accepted
accounting principles.
We also audited Schedule I of Meritage Hospitality Group Inc. and Subsidiaries
as of and for the year ended November 30, 1997 and Schedule II for the years
ended November 30, 1998, 1997 and 1996. In our opinion these schedules present
fairly, in all material respects, the information required to be set forth
therein.
Southfield, Michigan
December 19, 1998
M-1
33
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
NOVEMBER 30,
===========================================================================================
1997
ASSETS 1998 (RESTATED)
----------- -----------
CURRENT ASSETS
Cash and cash equivalents $ 2,109,358 $ 1,061,475
Receivables 70,974 258,282
Notes receivable, current portion 2,719,617 --
Inventories 165,156 156,746
Prepaid expenses and other current assets 90,796 156,028
----------- -----------
Total Current Assets 5,155,901 1,632,531
PROPERTY, PLANT AND EQUIPMENT, NET 13,182,940 7,518,007
NET ASSETS OF DISCONTINUED OPERATIONS -- 839,986
OTHER ASSETS
Note receivable, net of current portion 500,000 --
Goodwill, net of amortization of $153,758 and
$2,278,454, respectively 5,155,965 3,586,177
Franchise costs, net of amortization of $17,806 and
$406,552, respectively 632,194 143,448
Financing costs, net of amortization of $3,314 and
$34,208, respectively 261,815 50,239
Deferred charges and other assets 75,431 43,949
----------- -----------
Total Other Assets 6,625,405 3,823,813
----------- -----------
Total Assets $24,964,246 $13,814,337
=========== ===========
M-2
34
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - CONTINUED
NOVEMBER 30,
=================================================================================================
1997
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 (RESTATED)
------------ ------------
CURRENT LIABILITIES
Current portion of long-term debt $ 1,199,458 $ 1,098,495
Current portion of obligations under capital lease 294,577 264,372
Short-term borrowings 1,100,000 --
Trade accounts payable 727,199 813,855
Amount due related party 245,260 85,263
Income taxes payable 50,000 --
Accrued liabilities 1,308,987 837,230
----------- -----------
Total Current Liabilities 4,925,481 3,099,215
LONG-TERM DEBT 10,623,946 7,394,118
OBLIGATIONS UNDER CAPITAL LEASES 1,395,049 1,689,628
DEFERRED REVENUE 1,992,026 --
NET LIABILITIES OF DISCONTINUED OPERATIONS 593,855 --
COMMITMENTS AND CONTINGENCIES (NOTES J, K, Q AND R) -- --
MINORITY INTEREST -- 1,601,415
STOCKHOLDERS' EQUITY
Preferred stock - $0.01 par value; authorized 5,000,000
shares; 200,000 shares designated as Series A
convertible cumulative preferred stock; issued and
outstanding, 44,520 shares in 1998 (liquidation
value - $445,200) and 138,387 shares in 1997 445 1,384
Common stock - $0.01 par value; authorized
30,000,000 shares; issued and outstanding
5,742,586 and 3,218,778 shares, respectively 57,426 32,188
Additional paid in capital 13,299,467 12,982,295
Note receivable from sale of shares, net of
valuation allowance of $4,666,755 in 1998 (1,660,962) (5,700,645)
Accumulated deficit (6,262,487) (7,285,261)
----------- -----------
Total Stockholders' Equity 5,433,889 29,961
----------- -----------
Total Liabilities and Stockholders' Equity $24,964,246 $13,814,337
=========== ===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
M-3
35
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED NOVEMBER 30,
==================================================================================================================
1997 1996
1998 (RESTATED) (RESTATED)
----------- ----------- -----------
Food and beverage revenue $27,043,954 $26,860,546 $ 2,098,908
Cost and expenses
Cost of food and beverages 7,752,187 7,720,307 639,437
Operating expenses 15,647,438 15,856,833 1,316,348
General and administrative expenses 3,111,910 2,886,892 299,929
Depreciation and amortization 1,078,539 1,070,017 111,739
----------- ----------- -----------
Total costs and expenses 27,590,074 27,534,049 2,367,453
----------- ----------- -----------
Loss from operations (546,120) (673,503) (268,545)
Other income (expense)
Interest expense (1,473,019) (1,440,192) (142,857)
Interest income 184,614 592,850 658,007
Other income 509,590 -- --
Loss on disposal of assets (25,000) (218,602) --
Minority interest 25,677 (195,639) 21,079
----------- ----------- -----------
Total other income (expense) (778,138) (1,261,583) 536,229
----------- ----------- -----------
Earnings (loss) from continuing
operations before income taxes (1,324,258) (1,935,086) 267,684
Income taxes - current 50,000 -- --
----------- ----------- -----------
Earnings (loss) from continuing operations (1,374,258) (1,935,086) 267,684
Discontinued operations
Loss from operations (including
income tax benefit of $160,000, $15,000
and $20,000, respectively) (479,232) (1,057,568) (2,193,254)
Gain on disposal of discontinued operations 3,711,364 1,479,095 --
----------- ----------- -----------
Earnings (loss) from discontinued operations 3,232,132 421,527 (2,193,254)
----------- ----------- -----------
Earnings (loss) before extraordinary item 1,857,874 (1,513,559) (1,925,570)
Extraordinary item - loss on early extinguishment
of debt (no applicable federal income tax) 727,172 177,291 --
----------- ----------- -----------
Net earnings (loss) 1,130,702 (1,690,850) (1,925,570)
Preferred stock dividends 107,928 101,714 --
----------- ----------- -----------
Net earnings (loss) on common shares $ 1,022,774 $(1,792,564) $(1,925,570)
=========== =========== ===========
M-4
36
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS - CONTINUED
YEARS ENDED NOVEMBER 30,
===============================================================================================================
1997 1996
1998 (RESTATED) (RESTATED)
---------- ----------- ----------
Earnings (loss) per common share - basic and diluted
Continuing operations $ (.30) $ (.63) $ .09
Discontinued operations .66 .13 (.71)
Extraordinary item (.15) (.06) --
---------- ---------- ----------
Net earnings (loss) $ .21 $ (.56) $ (.62)
========== ========== ==========
Weighted average shares outstanding 4,932,738 3,214,836 3,081,885
========== ========== ==========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
M-5
37
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED NOVEMBER 30, 1998, 1997 AND 1996
==================================================================================================================================
SERIES A NOTE
CONVERTIBLE ADDITIONAL RECEIVABLE
PREFERRED COMMON PAID-IN SALE OF ACCUMULATED
STOCK STOCK CAPITAL SHARES DEFICIT TOTAL
------ ------- ----------- ----------- ----------- -----------
Balance at December 1, 1996 $ -- $30,200 $10,684,750 $(5,602,532) $(2,057,052) $ 3,055,366
Issuance of 108,387 shares of preferred
stock 1,084 -- 1,082,786 -- -- 1,083,870
Issuance of 184,333 shares of common
stock -- 1,845 1,139,281 -- -- 1,141,126
Recognition of interest income on note
receivable from sale of shares -- -- -- (573,274) -- (573,274)
Dividends paid ($.50 per common share) -- -- -- -- (1,510,075) (1,510,075)
Payment and present value adjustment
on note receivable from sale of shares -- -- (290,090) 1,040,090 -- 750,000
Net loss -- -- -- -- (1,925,570) (1,925,570)
------ ------- ----------- ----------- ----------- -----------
Balance at November 30, 1996 1,084 32,045 12,616,727 (5,135,716) (5,492,697) 2,021,443
Issuance of 14,295 shares of common
stock -- 143 65,868 -- -- 66,011
Issuance of 30,000 shares of preferred
stock 300 -- 299,700 -- -- 300,000
Dividends paid - preferred stock -- -- -- -- (101,714) (101,714)
Recognition of interest income on note
receivable from sale of shares -- -- -- (564,929) -- (564,929)
Net loss -- -- -- -- (1,690,850) (1,690,850)
------ ------- ----------- ----------- ----------- -----------
Balance at November 30, 1997 1,384 32,188 12,982,295 (5,700,645) (7,285,261) 29,961
M-6
38
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - CONTINUED
YEARS ENDED NOVEMBER 30, 1998, 1997 AND 1996
==================================================================================================================================
SERIES A NOTE
CONVERTIBLE ADDITIONAL RECEIVABLE
PREFERRED COMMON PAID-IN SALE OF ACCUMULATED
STOCK STOCK CAPITAL SHARES DEFICIT TOTAL
-------- --------- ----------- ----------- ----------- -----------
Balance at December 1, 1997 $ 1,384 $ 32,188 $12,982,295 $(5,700,645) $(7,285,261) $ 29,961
Issuance of 1,999,935 shares of common
stock -- 19,999 4,561,155 -- -- 4,581,154
Conversion of 73,867 shares of
convertible preferred shares into
523,873 common shares (739) 5,239 (4,500) -- -- --
Cancellation of 20,000 shares of
convertible preferred stock (200) -- (199,800) -- -- (200,000)
Dividends paid - preferred stock -- -- -- -- (107,928) (107,928)
Recognition of interest income on note
receivable from sale of shares 627,072 (627,072) -- --
Establishment of valuation allowance
on note receivable from sale
of shares -- -- (4,666,755) 4,666,755 -- --
Net earnings -- -- -- -- 1,130,702 1,130,702
-------- --------- ----------- ----------- ----------- -----------
Balance at November 30, 1998 $ 445 $ 57,426 $13,299,467 $(1,660,962) $(6,262,487) $ 5,433,889
======== ========= =========== =========== =========== ===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
M-7
39
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED NOVEMBER 30,
======================================================================================================================
1997 1996
1998 (RESTATED) (RESTATED)
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings (loss) $ 1,130,702 $(1,690,850) $(1,925,570)
Adjustments to reconcile net loss to net cash provided
by operating activities
Extraordinary item-loss on early extinguishment
of debt from continuing operations 45,038 -- --
Depreciation and amortization 1,078,539 1,070,017 111,739
Compensation paid by issuance of preferred and
common stock 6,288 52,492 310,099
Minority interest in (loss) earnings of consolidated
subsidiaries (25,677) 195,639 (21,079)
Loss on disposal of assets 25,000 218,602 --
Interest income on note receivable from sale of
shares -- (564,929) (573,274)
Interest expense refinanced as long-term debt -- 240,310 --
Increase in note receivable from sale of assets (3,219,617) -- --
(Increase) decrease in cash value of life insurance (8,884) 185,207 (10,391)
Increase in deferred revenue 1,992,026 -- --
Decrease (increase) in current assets
Receivables 187,308 (42,403) (16,946)
Inventories (8,410) 23,504 6,283
Prepaid expenses and other current assets 65,232 (14,159) (6,539)
(Decrease) increase in current liabilities
Trade accounts payable (86,656) (27,057) 61,032
Amount due related party 159,997 85,263 --
Income taxes payable 50,000 --
Accrued liabilities 471,757 (9,577) 2,830,480
Decrease (increase) in net assets (liabilities)
of discontinued operations 1,433,841 (573,275) (1,392,563)
----------- ----------- -----------
Net cash provided by (used in) operating
activities 3,296,484 (851,216) (626,729)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, plant and equipment (5,029,283) (608,071) (252,183)
Payment for franchise agreement (25,000) -- --
Acquisition of business, net of cash acquired (758,632) (182,526) (3,184,460)
Increase in other assets (34,191) (21,106) (99,088)
----------- ----------- -----------
Net cash used in investing activities (5,847,106) (811,703) (3,535,731)
M-8
40
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
YEARS ENDED NOVEMBER 30,
===================================================================================================================
1997 1996
1998 (RESTATED) (RESTATED)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt $10,408,217 $ 750,000 $ 8,337,306
Payment of financing costs (265,129) -- --
Proceeds from note payable 1,498,934 -- --
Principal payments of long-term debt (7,676,361) (270,467) (3,001,357)
Payments on obligations under capital lease (264,372) (232,441) (29,808)
Collection on note receivable from sale of shares -- -- 750,000
Proceeds from issuance of preferred and common
shares 5,144 313,519 545,000
Dividends paid (107,928) (101,714) (1,510,075)
----------- ----------- -----------
Net cash provided by financing activities 3,598,505 458,897 5,091,066
----------- ----------- -----------
Net increase (decrease) in cash 1,047,883 (1,204,022) 928,606
Cash and cash equivalents - beginning of year 1,061,475 2,265,497 1,336,891
----------- ----------- -----------
Cash and cash equivalents - end of year $ 2,109,358 $ 1,061,475 $ 2,265,497
=========== =========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest $ 1,341,384 $ 1,370,969 $ 448,283
Cash paid for income taxes -- -- --
SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Acquisition of remaining 46% of Wendy's of
West Michigan Limited Partnership, including
assets acquired and liabilities assumed
Fair value of tangible and intangible assets
acquired $ 3,751,619
Reduction of minority interest 1,575,738
Amount of cash payment (758,632)
------------
1,992,359 common shares issued $ 4,568,725
============
Assignment of note receivable
Amount of note receivable assigned $ 1,375,000
Cancellation of note payable (776,066)
Cancellation of 20,000 convertible preferred shares (200,000)
------------
Proceeds from note payable $ 398,934
============
M-9
41
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
YEARS ENDED NOVEMBER 30,
==========================================================================================================================
1997 1996
1998 (RESTATED) (RESTATED)
----------- --------- ----------
Conversion of 73,867 shares of convertible preferred
stock into 523,873 shares of common stock $ --
===========
Acquisition of equipment
Cost of equipment $244,637
Equipment loan 244,637
--------
Cash down payment for equipment $ --
========
Increase in long term debt due to three month moratorium
on interest and principal payments $240,310
========
Acquisition of majority equity interest in Wendy's of
West Michigan Limited Partnership, including assets
acquired and liabilities assumed
Fair value of assets, net of cash acquired $10,532,850
Liabilities assumed 7,348,390
-----------
$ 3,184,460
===========
In connection with this acquisition, the Company
issued 171,900 shares of common stock and
29,520 shares of preferred stock with a value of
$1,369,575 $ --
===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
M-10
42
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOVEMBER 30, 1998, 1997 AND 1996
================================================================================
NOTE A - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
The Company currently conducts its business in the quick-service restaurant
industry operating twenty-five Wendy's Old Fashioned Hamburger restaurants under
franchise agreements with Wendy's International, Inc. All operations of the
Company are located in Michigan. The Company formerly conducted business in its
discontinued lodging industry segment which consisted of three full service
hotels. The hotels were sold during 1997 and 1998 (see Notes C and E).
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
the following wholly-owned subsidiaries:
Continuing operations:
MHG Food Service Inc.
Discontinued operations:
SC Inn Inc., TE Inn Inc., GHR Inc., and GHYC Inc.
All significant intercompany balances and transactions have been eliminated in
consolidation.
INVENTORIES
Inventories are stated at the lower of cost or market as determined by the
first-in, first-out method. Inventories consist of restaurant food items,
beverages and paper supplies.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost. Depreciation is computed
principally using the straight-line method based upon estimated useful lives
ranging from 3 to 30 years. Amortization of leasehold improvements is provided
over the terms of the various leases.
INCOME TAXES
Income taxes are accounted for by using an asset and liability approach.
Deferred tax assets and liabilities are recognized for the expected future tax
consequences of temporary differences between the financial basis and tax basis
of assets and liabilities. Assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled.
M-11
43
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1998, 1997 AND 1996
================================================================================
NOTE A - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FRANCHISE FEES
Franchise fees for the Company's restaurant units are amortized using the
straight-line method over the terms of the individual franchise agreements
including options to renew.
FINANCING COSTS
Financing costs are amortized using the straight-line method over the terms of
the various loan agreements.
GOODWILL AND LONG-LIVED ASSETS
The cost in excess of net assets acquired (goodwill) is amortized using the
straight-line method over thirty years (the term of the franchise agreements
including options to renew). The Company performs a review for impairment when
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Undiscounted estimated future cash flows of an asset are
compared with its carrying value and if the cash flows are less than the
carrying value, an impairment loss is recognized. There is no impact on the
financial statements due to this review.
OBLIGATIONS UNDER CAPITALIZED LEASES
Lease transactions relating to certain restaurant buildings and equipment are
classified as capital leases. These assets have been capitalized and the related
obligations recorded based on the fair market value of the assets at the
inception of the leases. Amounts capitalized are being amortized over the terms
of the leases.
FRANCHISE COSTS AND OTHER ADVERTISING COSTS
Royalties and advertising costs are based primarily on a percentage of monthly
sales. These costs and other advertising costs are charged to operations as
incurred. Advertising expense from continuing operations totaled $1,553,193,
$1,638,409 and $124,867 for the years ended November 30, 1998, 1997 and 1996,
respectively.
USE OF ESTIMATES
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
M-12
44
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1998, 1997 AND 1996
================================================================================
NOTE A - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EARNINGS (LOSS) PER SHARE
The Company adopted SFAS No. 128, "Earnings Per Share," issued by the Financial
Accounting Standards Board (FASB) effective for fiscal years ending after
December 15, 1997. This new standard eliminates primary and fully diluted
earnings per share and requires presentation of basic and diluted earnings per
share. Basic earnings per share is computed by dividing earnings on common
shares by the weighted average number of common shares outstanding during each
year. Diluted earnings per share reflect per share amounts that would have
resulted if dilutive potential common stock had been converted to common stock.
All prior period earnings per share data has been restated accordingly.
The following table reconciles the numerators and denominators used to calculate
basic and diluted earnings per share for the years ended November 30, 1998, 1997
and 1996:
1998 1997 1996
----------- ----------- -----------
Numerators
Earnings (loss) from continuing
operations $(1,374,258) $(1,935,086) $ 267,684
Less preferred stock dividends 107,928 101,714 --
----------- ----------- -----------
Earnings (loss) on common shares -
basic and diluted $(1,482,186) $(2,036,800) $ 267,684
=========== =========== ===========
Denominators
Weighted average common shares
outstanding - basic and diluted 4,932,738 3,214,836 3,081,885
=========== =========== ===========
Convertible preferred stock was not included in the computation of diluted
earnings per common share because the effect of conversion would be
antidilutive. Exercisable stock options were not included in the computation of
diluted earnings per share because the option prices were greater than average
quarterly market prices.
CASH EQUIVALENTS
For purposes of the statement of cash flows, the Company considers all highly
liquid debt instruments purchased with a maturity of three months or less to be
cash equivalents.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Company's financial instruments which include cash
and cash equivalents, receivables, notes receivable, accounts payable and
short-term and long-term debt, approximate their fair values.
M-13
45
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1998, 1997 AND 1996
================================================================================
NOTE A - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FINANCIAL STATEMENT PRESENTATION
Certain amounts in the 1997 and 1996 financial statements have been reclassified
to conform to the 1998 presentation.
NEW PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (FASB) issued FSAS No.
130, "Reporting of Comprehensive Income," which establishes standards for
reporting and display of comprehensive income and its components (revenues,
expenses, gains, and losses) in a full set of financial statements. This
statement also requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. This statement is effective for fiscal years beginning
after December 15, 1997. Reclassification of financial statements for earlier
periods provided for comparative purposes is required. The Company does not
anticipate that adoption of SFAS No. 130 will have any effect on its financial
statements.
NOTE B - ACQUISITION
In fiscal 1996, the Company purchased 54% of the partnership interest in the now
dissolved Wendy's of West Michigan Limited Partnership (the "Wendy's
Partnership"). Certain of the units in the Wendy's Partnership were purchased
from stockholders/directors at prices no more favorable than that paid to
non-related unitholders. The Company then transferred this interest to its
wholly-owned subsidiary, MHG Food Service Inc. The remaining 46% of the Wendy's
Partnership was acquired by the Company in January 1998. The acquisition has
been accounted for as a purchase and the total acquisition cost of $10,384,753,
($4,446,453 cash, 2,164,259 shares of common stock and 29,520 shares of
preferred stock with a total value of $5,938,300), has been allocated to assets
acquired and liabilities assumed based upon estimates of their fair values. A
total of $5,309,723, representing the excess of the acquisition cost over the
fair value of net assets acquired has been allocated to goodwill.
The Company's consolidated results of operations include the Wendy's Partnership
activity from November 1, 1996 (effective date of acquisition). The unaudited
pro forma information below presents combined results of operations as if 100%
of the acquisition had occurred at the beginning of the periods presented. The
unaudited pro forma information is not necessarily indicative of the results of
operations of the combined Company had the acquisition occurred at the beginning
of the periods presented.
YEARS ENDED NOVEMBER 30, (UNAUDITED)
-------------------------------------------------
1997 1996
1988 (RESTATED) (RESTATED)
----------- ----------- -----------
Revenues $27,044,000 $26,860,000 $26,406,000
Net loss from continuing operations $(1,350,000) $(1,739,000) $ (368,000)
Loss per share $ (.30) $ (.57) $ (.12)
M-14
46
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1998, 1997 AND 1996
================================================================================
NOTE C - DISCONTINUED OPERATIONS - SALE OF HOTEL ASSETS
The Company sold substantially all the assets of its three full service hotels,
which were previously included in the lodging segment. As such, the Company
began reporting the lodging segment as discontinued operations effective May 31,
1998. The consolidated financial statements have been restated for all prior
periods presented to reflect the results of operations and net assets of the
lodging segment as discontinued operations.
A summary of the three sale transactions is as follows:
Grand Harbor
Resort
Thomas Edison Inn & Yacht Club St. Clair Inn
----------------- ------------ -------------
Date of sale September 1, 1998 June 15, 1998 November 30, 1997
Selling price (before selling costs) $12,200,000 $4,500,000 $3,800,000
Promissory note held by Company 2,000,000 1,375,000 --
----------- ---------- ----------
Cash portion of selling price $10,200,000 $3,125,000 $3,800,000
=========== ========== ==========
Gain on sale of assets $ 3,273,893 $ 583,164 $1,479,095
Loss from operations from
measurement date (May 31, 1998)
to date of disposal 109,800 35,893 --
----------- ---------- ----------
Gain on disposal of
discontinued operations $ 3,164,093 $ 547,271 $1,479,095
=========== ========== ==========
As of November 30, 1998 and 1997, assets and liabilities of the discontinued
lodging group business segment included in the balance sheet are summarized
below:
NOVEMBER 30,
---------------------------------
1997
1998 (RESTATED)
---------- ------------
Assets
Current assets $ 13,264 $ 4,221,735
Property, plant and equipment, net -- 11,461,306
Other assets 16,511 2,815,877
Liabilities
Current liabilities (623,630) (4,938,619)
Long-term debt -- (11,980,313)
Other liabilities -- (740,000)
---------- ------------
Net assets (liabilities) of
discontinued operations $ (593,855) $ 839,986
========== ============
M-15
47
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1998, 1997 AND 1996
================================================================================
NOTE C - DISCONTINUED OPERATIONS - SALE OF HOTEL ASSETS (CONTINUED)
The results of operations of the discontinued operations for the years ended
November 30, 1998, 1997 and 1996 is summarized below:
For years ended November 30, 1998 1997 1996
---------- ----------- -----------
Revenues $6,358,126 $14,034,053 $14,762,822
Earnings (loss) from operations $ 151,934 $ 478,153 $ (706,476)
Earnings (loss) from discontinued operations $3,232,132 $ 421,527 $(2,193,254)
NOTE D - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are summarized as follows at November 30:
1997
1998 (RESTATED)
----------- -----------
Land and improvements $ 2,861,000 $ 749,000
Buildings and improvements 5,515,359 3,832,351
Furnishings and equipment 3,547,990 5,346,438
Leasehold improvements 1,009,191 2,153,600
Leased property/capital leases 983,292 2,825,338
Construction in progress 75,390 --
----------- -----------
13,992,222 14,906,727
Less accumulated depreciation and amortization (809,282) (7,388,720)
----------- -----------
$13,182,940 $ 7,518,007
=========== ===========
Depreciation and amortization expense was approximately $853,000, $768,000 and
$79,000 for the years ended November 30, 1998, 1997 and 1996, respectively.
M-16
48
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1998, 1997 AND 1996
================================================================================
NOTE E - NOTES RECEIVABLE
The Company received a note receivable as partial consideration in the sale of
both the Grand Harbor Resort & Yacht Club and the Thomas Edison Inn. Notes
receivable consisted of the following at November 30:
1998 1997
---------- ----------
Mortgage note receivable (from sale of Grand Harbor
Resort & Yacht Club), collateralized by marina real
estate, requiring monthly payments of interest only at
10.8% through June 16, 1999, when any remaining
balance is due, unless the balance is $500,000 or less,
which allows the terms of the note to be extended
through December 16, 1999, when any remaining
balance is due. $1,375,000 $ --
Mortgage note receivable (from sale of Thomas
Edison Inn), collateralized by land and the pledge of
stock of an affiliate of the borrower, requiring
monthly payments of interest only at prime plus 8%
through August 31, 1999, when any remaining
balance is due. 1,844,617
---------- ----------
3,219,617 --
Less current portion 2,719,617 --
---------- ----------
$ 500,000 $ --
========== ==========
NOTE F - AMOUNTS DUE RELATED PARTIES AND RELATED PARTY TRANSACTIONS
The Company sold $1,100,000 of undivided interests in the $2,000,000 mortgage
note received from the sale of the Thomas Edison Inn (see Notes C and E). The
participation agreements represent 59.6% of the outstanding note balance, of
which a 27.1% participation ($500,000) was sold to a member of the Company's
Board of Directors. The participation agreements require monthly payments of
interest only at prime plus 8% through August 31, 1999 when any remaining
balance is due. The Company indemnified each of the participants in the event of
nonpayment by the maker.
Effective October 6, 1998, the Company entered into an agreement with the
Company's Chairman of the Board whereby the company assigned the $1,375,000
(10.8%) one year mortgage note receivable from the sale of the Grand Harbor
Resort & Yacht Club (see Note C and E) to the Chairman in exchange for (i)
payment in full of the prime plus 8% business loan note payable to the Chairman
($776,000), (ii) cancellation of $200,000 of preferred stock owned by the
Chairman, and (iii) a cash payment of $399,000. The payment terms, interest
rate, and related security are the same as the assigned note receivable (see
Note E). The Company indemnified the Chairman in the event of nonpayment by the
maker.
M-17
49
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1998, 1997 AND 1996
================================================================================
NOTE F - AMOUNTS DUE RELATED PARTIES AND RELATED PARTY TRANSACTIONS (CONTINUED)
The Wendy's Partnership incurred a management fee to the General Partner in the
amount of $160,000 in 1998 and 1997 and $13,333 in 1996 (effective date of the
Wendy's Partnership acquisition was November 1, 1996.)
NOTE G - ACCRUED LIABILITIES
Accrued liabilities consist of the following at November 30:
1997
1998 (RESTATED)
---------- --------
Payroll and related payroll taxes $ 787,394 $434,891
Property taxes 238,953 221,180
Professional fees 69,125 61,450
Interest and other expenses 213,515 119,709
---------- --------
$1,308,987 $837,230
========== ========
M-18
50
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1998, 1997 AND 1996
================================================================================
NOTE H - LONG-TERM DEBT
Long-term debt consists of the following obligations at November 30:
1997
1998 (RESTATED)
---------- ----------
Mortgage notes payable, due in
monthly installments of $40,146
including interest at 7.77% through
October 1, 2018. (1) $4,861,387 --
Mortgage notes payable, due in
monthly installments of $32,226
including interest at 8.15% through
September 1, 2018. (1) 3,797,257 --
Notes payable, due in monthly
installments of $10,802 including
interest at 8.15% through September
1, 2013. (1) 1,113,588 --
Construction note payable, due in
monthly installments of interest
only at 7.27%, through completion
of the building construction. (1) 310,717 --
Amount payable to the Chairman of the
Board and shareholder, due in
monthly installments of interest
only at 10.8% through December 16,
1999 when any remaining principal
will be due. (1) 1,375,000 --
Other notes payable, requiring
monthly payments aggregating
$19,416 and $13,454, respectively,
subject to interest at rates
ranging from 7.5% to 10.0%. (2) 365,455 215,192
Mortgage note payable, as amended,
due in monthly installments of
interest at prime plus 8%. The note
was paid in full in October 1998. -- 5,469,543
Term note payable, due in monthly
installments of $43,313, including
interest at 1% over prime. The note
was paid in full in September 1998. -- 2,037,111
Note payable to Chairman of the
Board and shareholder, unsecured,
interest due monthly at prime plus
8%. The note was retired as part of
the assignment of the $1,375,000
note receivable from the sale of
the Grand Harbor Resort & Yacht
Club. -- 770,767
---------- ----------
11,823,404 8,492,613
Less current portion 1,199,458 1,098,495
----------- ----------
$10,623,946 $7,394,118
=========== ==========
(1) The debt is collateralized by certain real estate.
(2) The note is collateralized by certain equipment.
M-19
51
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1998, 1997 AND 1996
================================================================================
NOTE H - LONG-TERM DEBT (CONTINUED)
Minimum principal payments on long-term debt to maturity as of November 30, 1998
are as follows:
1999 $ 1,199,458
2000 824,692
2001 326,818
2002 353,544
2003 382,458
Thereafter 8,736,434
-----------
$11,823,404
===========
Loan covenants of the various loan agreements include requirements for
maintenance of certain financial ratios. At November 30, 1998 the Company was in
compliance.
NOTE I - INCOME TAXES
Deferred tax assets and liabilities at November 30, consist of the following:
1997
1998 (RESTATED)
--------- ---------
Deferred tax assets:
Net operating loss carryforwards $ 288,000 $ 857,000
AMT credit carryforward 155,000 105,000
Allowance for doubtful accounts 213,000 --
Depreciation 16,000 --
Goodwill 11,000 --
Accrued Compensation 15,000 --
Contribution carryforward -- 8,000
--------- ---------
698,000 970,000
Deferred tax liabilities
Depreciation (26,000) --
Amortization (54,000) --
Capital leases (10,000) --
--------- ---------
(90,000) --
Less valuation allowance (608,000) (970,000)
--------- ---------
Net deferred tax liability $ -- $ --
========= =========
The net operating loss carryforwards expire in 2011 - 2012.
M-20
52
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1998, 1997 AND 1996
================================================================================
NOTE I - INCOME TAXES (CONTINUED)
The income tax provision reconciled to the tax computed at the statutory federal
rate for continuing operations was as follows:
YEARS ENDED NOVEMBER 30,
---------------------------------------
1997 1996
1998 (RESTATED) (RESTATED)
--------- --------- ---------
Tax expense (benefit) at statutory rates
applied to income before federal
income tax $(450,000) $(657,600) $ 91,000
Effect of nondeductible items 44,400 82,400 (51,000)
IRS adjustment to net operating loss -- 250,000 --
Other 21,600 (8,500) (4,000)
Valuation allowance 434,000 333,700 (36,000)
--------- --------- ---------
$ 50,000 $ -- $ --
========= ========= =========
NOTE J - LEASE COMMITMENTS
The Company leases land and buildings used in operations under operating
agreements, with remaining lease terms (including renewal options of up to
twelve years) ranging from one to twenty-two years. Included in the leases were
five with a real estate partnership related through common general partnership
ownership through May 19, 1997 when the former general partner was removed.
Total lease expense (including taxes, insurance and maintenance when included in
rent) related to all operating leases and all percentage rentals is as follows:
YEARS ENDED NOVEMBER 30,
-------------------------------------
1998 1997 1996
Leases with related parties
Minimum rentals $ -- $ 143,127 $25,256
Percentage rentals -- 79,948 14,155
Other Leases
Minimum rentals 631,178 583,365 46,347
Percentage rentals 523,033 459,463 7,887
---------- ---------- -------
$1,154,211 $1,265,903 $93,645
========== ========== =======
M-21
53
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1998, 1997 AND 1996
================================================================================
NOTE J - LEASE COMMITMENTS (CONTINUED)
Certain restaurant leases (eight restaurant buildings, excluding land
which is accounted for as an operating lease) and equipment leases have
been capitalized. Minimum future obligations under capital leases and
noncancellable operating leases in effect are as follows:
CAPITAL OPERATING
YEARS ENDED NOVEMBER 30, LEASES LEASES
------------------------ ---------- ----------
1999 $ 465,323 $ 403,321
2000 465,323 372,422
2001 449,365 254,440
2002 369,575 225,273
2003 369,575 214,440
Thereafter 30,798 182,370
---------- ----------
Total minimum lease obligations 2,149,959 $1,652,266
==========
Less amount representing interest imputed at
approximately 11% 460,333
----------
Present value of minimum lease obligations $1,689,626
==========
The present value of minimum rental obligations is reflected in the balance
sheets as current and long-term obligations under capital leases.
Accumulated amortization of leased property under capital leases was $138,500,
and $1,814,346, at November 30, 1998 and 1997, respectively.
In addition to minimum future obligations, percentage rentals may be paid under
all restaurant leases on the basis of percentage of sales in excess of minimum
prescribed amounts.
NOTE K - DEFERRED REVENUE
In April 1998, the Company entered into a long-term agreement with its beverage
supplier. The agreement requires the Company to purchase 1,800,000 gallons of
fountain beverage syrup from the supplier. In exchange, the Company received
$2,090,000 in marketing and conversion funds which, in accordance with the terms
of the agreement, will be recognized as revenue as the gallons of fountain
beverage syrup are purchased.
M-22
54
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1998, 1997 AND 1996
================================================================================
NOTE L - SERIES A CONVERTIBLE CUMULATIVE PREFERRED STOCK
In 1996, the Company designated a series of non-voting preferred stock
consisting of 200,000 shares of $0.01 par value. The shares have an annual
dividend rate of $0.90 per share and the payment of the dividends are
cumulative. The shares were also convertible into common shares at the
conversion price of $7.00 per share through July 31, 1998, when a new conversion
pricing formula was adopted. For the period of August 1, 1998 through September
14, 1998, the shares were convertible into common shares at the conversion price
of $1.41 per share. The conversion price increased by $1.00 on September 15,
1998 and will continue to increase by $1.00 on the 15th of each December, March,
June and September thereafter until the conversion price reaches $7.00 per
share, at which time no further increases will occur. The shares have a
liquidation value of $10.00 per share.
Under certain conditions relating to the market value of the Company's common
stock, the Company has the option to cause the preferred stock to be converted
into common stock.
In August and September 1998, the Company issued 523,873 unregistered common
shares in connection with the conversion 73,867 convertible preferred shares.
The preferred shares had been purchased in 1996 and 1997, and were convertible
into common shares at a conversion price of $1.41 per common share in accordance
with the conversion program described above (based on the liquidation value of
$10.00 per preferred share). Preferred dividends paid will be reduced by $66,480
annually due to this conversion.
NOTE M - NOTE RECEIVABLE FROM SALE OF SHARES
On September 19, 1995, a stock purchase and sale agreement (Agreement) was
executed by the Company, its then principal stockholder, and CBH Capital Corp.
("CBHCC") (formerly Meritage Capital Corp.). Under the agreement, the Company
sold 1,500,000 shares of previously authorized newly issued common stock to
CBHCC at a total price of $10,500,000. Upon execution of the agreement, CBHCC
gave the Company a non-interest bearing promissory note in the amount of
$10,500,000. The Note provides that CBHCC does not have to make any payments to
the Company for five years from the date of the Note (September 19, 1995).
Beginning on the fifth anniversary of the Note, CBHCC is required to make six
annual payments of $1,625,000.
The Note is collateralized by the shares issued to CBHCC under the Agreement.
The Note was discounted at 11% and is recorded as a reduction of stockholders'
equity. Due to the change in market value of the shares collateralizing the
loan, a valuation allowance of $4,666,755 was recorded as of November 30, 1998.
During the year ended November 30, 1996 the Company received an unscheduled
principal payment of $750,000. As a result, the present value of the note was
recalculated and reduced by approximately $290,000.
M-23
55
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1998, 1997 AND 1996
================================================================================
NOTE N - EMPLOYEE BENEFIT PLANS
The Company maintained a defined contribution 401(k) plan that covered
substantially all employees of the discontinued lodging industry segment. The
plan was terminated November 30, 1997 and all plan assets will be distributed to
plan participants subsequent and subject to compliance with various governmental
regulations.
The Company maintains a 401(k) profit sharing plan that covers substantially all
of its employees in the quick-service restaurant business. Contributions to the
plan may be made by the Company (which are discretionary) or by plan
participants through elective salary reductions. Contributions to the plan by
the Company totaled $27,720, $27,765 and $2,000 in 1998, 1997 and 1996,
respectively.
NOTE O - OTHER INCOME
Other income of $509,590 in 1998 consisted primarily of income from the
forfeiture of an earnest deposit in the amount of $500,000 on a contract to sell
one of the Company's hotel properties.
NOTE P - STOCK OPTION PLANS
The 1996 Management Equity Incentive Plan, as amended, authorized 725,000 shares
of common stock to be granted for options that may be issued under the plan. The
Board of Directors has the discretion to designate an option to be an incentive
share option or a non-qualified share option. The plan provides that the option
price is not less than the fair market value of the common stock at the date of
grant. Unless the option agreement provides otherwise, options granted under the
plan become exercisable on a cumulative basis at the rate of 20 percent during
each of the second through sixth years after the date of grant. Options granted
under the plan may have a term of from one to ten years.
The 1996 Directors' Share Option Plan, as amended, provides for the
non-discretionary grant of options to non-employee directors of the Company to
purchase a combined maximum of 120,000 shares. The plan provides that the option
price is the fair market value of the common stock on the date of grant. The
plan provides that each non-employee director, on the date such person becomes a
non-employee director, will be granted options to purchase 5,000 shares of
stock. Provided that such person is still serving as a non-employee director,
they will automatically be granted options to purchase 1,000 additional shares
each year thereafter on the date of the Annual Shareholders' Meeting. Options
granted under the plan have a term of ten years.
M-24
56
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1998, 1997 AND 1996
================================================================================
NOTE P - STOCK OPTION PLANS (CONTINUED)
The following table summarizes the changes in the number of common shares under
stock options granted pursuant to the preceding plans:
1996 MANAGEMENT 1996 DIRECTORS'
EQUITY INCENTIVE PLAN STOCK OPTION PLAN
--------------------------------- --------------------------------
AVERAGE OPTION AVERAGE OPTION
SHARES UNDER PRICE SHARES UNDER PRICE
OPTIONS PER SHARE OPTIONS PER SHARE
------------ -------------- ------------- --------------
Outstanding at
December 1, 1995 -- --
Granted during 1996 190,000 50,000
------- ------
Outstanding at
November 30, 1996 190,000 $7.00 50,000 $7.00
===== =====
Granted during 1997 143,500 6,000
Forfeited during 1997 (35,000) --
------- ------
Outstanding at
November 30, 1997 298,500 $7.00 56,000 $4.00
===== =====
Granted during 1998 147,500 18,000
Forfeited during 1998 (178,500) --
------- ------
Outstanding at
November 30, 1998 267,500 $3.50 74,000 $1.40
======= ===== ====== =====
Exercisable at:
November 30, 1996 -- 50,000
======= ======
November 30, 1997 28,500 56,000
======= ======
November 30, 1998 48,500 74,000
======= ======
Available for grant at:
November 30, 1996 110,000 10,000
======= ======
November 30, 1997 171,500 64,000
======= ======
November 30, 1998 457,500 46,000
======= ======
The Financial Accounting Standard Board has issued Statement No. 123,
"Accounting for Stock Based Compensation" ("SFAS No. 123"). The Statement
established a fair value method of accounting for employee stock options and
similar equity instruments such as warrants, and encourages all companies to
adopt that method of accounting for all of their stock compensation plans.
However, the statement allows companies to continue measuring compensation for
such plans using accounting guidance in place prior to SFAS No. 123. Companies
that elect to remain with the former method of accounting must make pro-forma
disclosures of net earnings and earnings per share as if the fair value method
provided for in SFAS No. 123 had been adopted.
M-25
57
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1998, 1997 AND 1996
================================================================================
NOTE P - STOCK OPTION PLANS (CONTINUED)
The fair value of each grant is estimated on the date of grant using the
Black-Scholes option - pricing model with the following weighted average
assumptions for grants in 1998: dividend yield of 0%, expected volatility
ranging from 81.6% - 83.6% in 1998 and 10.5% - 63.4% in 1997, risk-free interest
rates ranging from 4.8% - 5.8% in 1998 and 6.2% - 7.0% in 1997 and expected life
of ten years.
The Company has not adopted the fair value accounting provisions of SFAS No.
123. Accordingly, SFAS No. 123 has no impact on the Company's financial position
or results of operations.
The Company accounts for the stock option plan under APB Opinion No. 25,
"Accounting for Stock Issued to Employees." No compensation costs have been
recognized. Had compensation cost for the plan been determined based on the fair
value of the options at the grant dates consistent with the method of SFAS No.
123, the Company's net loss and loss per share would have been as follows:
YEARS ENDED NOVEMBER 30,
---------------------------
1998 1997
---------- -----------
Net earnings (loss)
As reported $1,130,702 $(1,690,850)
Pro forma $ 955,272 $(2,196,909)
Earnings (loss) per share
As reported $ .21 $ (0.56)
Pro forma $ .17 $ (0.72)
NOTE Q - COMMITMENTS AND CONTINGENCIES
The Company has entered into mortgage note agreements in the amount of
$1,940,000 to finance the land and building for two new Wendy's restaurants. The
mortgage notes carry a 20 year term with an interest rate equal to 2.75% over
the then current 10 year treasury rate. The interest rate will be fixed as of
the date that construction is completed, which is expected in February and March
1999. As of November 30, 1998, the Company had borrowed $310,717 on these loans.
The available construction draws will be sufficient to fund the remaining
construction costs.
The Company has also received a forward commitment in the amount of $3,750,000
to finance the land, building and equipment for three additional restaurants.
This commitment is for 20 year mortgages and 7 year equipment loans at an
interest rate equal to 4% and 5% over the then current same term treasury rate
subject to a minimum interest rate of 9% and 10.5% for real estate and equipment
financing, respectively. The Company has no obligation to utilize this
financing.
M-26
58
MERITAGE HOSPITALITY GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOVEMBER 30, 1998, 1997 AND 1996
================================================================================
NOTE Q - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Uncertainty due to Year 2000 Issue - The Year 2000 Issue arises because many
computerized systems use two digits rather than four to identify a year.
Date-sensitive systems may recognize the year 2000 as 1900 or some other date,
resulting in errors when information using year 2000 dates is processed. In
addition, similar problems may arise in some systems which use certain dates in
1999 to represent something other than a date. The effects of the Year 2000
issue may be experienced before, on, or after January 1, 2000, and, if not
addressed, the impact on operations and financial reporting may range from minor
errors to significant systems failure which could affect an entity's ability to
conduct normal business operations. It is not possible to be certain that all
aspects of the year 2000 issue affecting the entity, including those related to
the efforts of customers, suppliers, or other third parties, will be fully
resolved.
NOTE R - LEGAL PROCEEDINGS
The Company is involved in certain routine legal proceedings which are
incidental to its business. All of these proceedings arose in the ordinary
course of the Company's business and, in the opinion of the Company, any
potential liability of the Company with respect to these legal actions will not,
in the aggregate, be material to the Company's financial condition or
operations. The Company maintains various types of insurance standard to the
industry which would cover most actions brought against the Company.
M-27
59
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
MERITAGE HOSPITALITY GROUP INC.
CONDENSED BALANCE SHEET
NOVEMBER 30, 1997
ASSETS
Current assets:
Cash and cash equivalents $ 118,716
Receivable from sale of subsidiary's assets 3,187,782
Other current assets 29,025
-----------
Total current assets 3,335,523
Property, plant and equipment, net 301,952
Investments in and advances to subsidiaries 17,455,533
Deferred income taxes 550,000
Other assets 402,281
-----------
Total assets $22,045,289
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Current Liabilities:
Current portion of long-term debt $ 4,438,776
Other current liabilities 377,532
-----------
Total current liabilities 4,816,308
Deferred income taxes 740,000
Long-term debt 16,459,020
-----------
Total liabilities 22,015,328
STOCKHOLDERS' EQUITY
Capital stock 7,315,222
Accumulated deficit (7,285,261)
-----------
Total stockholders' equity 29,961
-----------
Total liabilities and stockholders' equity $22,045,289
===========
M-28
60
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
MERITAGE HOSPITALITY GROUP INC.
CONDENSED STATEMENT OF OPERATIONS
YEAR ENDED NOVEMBER 30, 1997
REVENUE
Equity in earnings of subsidiaries $ 2,595,397
Interest and dividend income 579,394
-----------
Total revenue 3,174,791
EXPENSES
General and administrative expenses 1,948,781
Depreciation and amortization 292,300
Interest expense 2,462,269
-----------
Total expenses 4,703,350
-----------
Loss before federal income tax (1,528,559)
Federal income tax benefit (15,000)
-----------
Loss before extraordinary item (1,513,559)
Extraordinary item - loss on early extinguishment
of debt (no applicable federal income tax) 177,291
-----------
Net loss (1,690,850)
Preferred stock dividends 101,714
-----------
Net loss on common shares $(1,792,564)
===========
M-29
61
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
MERITAGE HOSPITALITY GROUP INC.
CONDENSED STATEMENT OF CASH FLOWS
YEAR ENDED NOVEMBER 30, 1997
NET CASH USED IN OPERATING ACTIVITIES $(2,429,935)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, plant and equipment (35,166)
Decrease in other assets 149,136
-----------
Net cash provided by investing activities 113,970
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt 750,000
Principal payments of long-term debt (295,328)
Proceeds from issuance of preferred and common shares 313,519
Dividends paid (101,714)
-----------
Net cash provided by financing activities 666,477
-----------
Net decrease in cash (1,649,488)
Cash and cash equivalents - beginning of year 1,768,204
-----------
Cash and cash equivalents - end of year $ 118,716
===========
M-30
62
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Additions
----------------------------------
Balance at (1) (2)
beginning Charged to Charged to other Deductions- Balance at
Description of period Cost & Expenses accounts-describe describe end of period
- -------------------------------------------------------------------------------------------------------------
VALUATION ALLOWANCE FOR DEFERRED TAX ASSETS:
Year ended November 30:
1998 $970,000 -0- $(362,000)* -0- $608,000
1997 729,000 -0- 241,000* -0- 970,000
1996 39,300 -0- 689,700* -0- 729,000
* Increase (decrease) to adjust allowance to the amount of net deferred taxes.
M-31
63
INDEPENDENT AUDITORS' REPORT
To the Partners
Wendy's of West Michigan
Limited Partnership
Kalamazoo, Michigan
We have audited the accompanying balance sheets of Wendy's of West Michigan
Limited Partnership as of November 30, 1997 and 1996, and the related statements
of income, changes in partners' equity and cash flows for the year ended
November 30, 1997, eleven months ended November 30, 1996 and year ended December
31, 1995. These financial statements are the responsibility of the Partnership's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Wendy's of West Michigan
Limited Partnership at November 30, 1997 and 1996, and the results of its
operations and its cash flows for the year ended November 30, 1997, eleven
months ended November 30, 1996 and year ended December 31, 1995, in conformity
with generally accepted accounting principles.
January 9, 1998, except for Notes 6 and 7
which are as of January 30, 1998
W-1
64
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
BALANCE SHEETS
===================================================================================================================
November 30, 1997 1996
- -------------------------------------------------------------------------------------------------------------------
ASSETS (Note 3)
CURRENT ASSETS
Cash $ 601,562 $ 394,066
Receivables, including amounts due from related parties 258,282 215,879
Inventories 156,746 180,250
Prepaid expenses 149,003 125,445
- -------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 1,165,593 915,640
- -------------------------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT
Land 749,000 749,000
Leasehold improvements 2,144,520 2,192,253
Buildings and improvements 2,398,127 2,398,127
Furnishings and equipment 4,893,418 4,296,289
Vehicles 79,734 79,734
Leased property under capital leases (Note 4) 2,825,338 2,825,338
- -------------------------------------------------------------------------------------------------------------------
13,090,137 12,540,741
Less accumulated depreciation and amortization 7,236,594 6,643,697
- -------------------------------------------------------------------------------------------------------------------
NET PROPERTY AND EQUIPMENT 5,853,543 5,897,044
- -------------------------------------------------------------------------------------------------------------------
OTHER ASSETS
Goodwill, net of amortization of $2,179,320 and $1,981,200
1,782,967 1,981,087
Franchise fees, net of amortization of $406,552 and $395,488
153,448 154,512
Other 70,130 127,404
- -------------------------------------------------------------------------------------------------------------------
TOTAL OTHER ASSETS 2,006,545 2,263,003
- -------------------------------------------------------------------------------------------------------------------
$ 9,025,681 $ 9,075,687
===================================================================================================================
W-2
65
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
BALANCE SHEETS
===================================================================================================================
November 30, 1997 1996
- -------------------------------------------------------------------------------------------------------------------
LIABILITIES AND PARTNERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 591,773 $ 770,770
Accruals:
Salaries and wages 368,611 349,320
Taxes 258,854 267,698
Percentage rent 88,086 107,257
Other current liabilities, including amounts due to related parties
51,492 38,546
Current maturities of long-term debt (Note 3) 126,294 --
Current maturities of obligations under capital leases (Note 4)
264,372 232,442
- -------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 1,749,482 1,766,033
DEFERRED COMPENSATION (Note 2) -- 61,444
OBLIGATIONS UNDER CAPITAL LEASES, less current maturities (Note 4)
1,689,628 1,953,999
LONG-TERM DEBT, less current maturities (Note 3) 2,059,411 2,192,351
- -------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 5,498,521 5,973,827
- -------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (Notes 1, 4, 5, 6 and 7)
PARTNERS' EQUITY (Note 1)
Limited Partners 3,551,822 3,130,775
General Partner (24,662) (28,915)
- -------------------------------------------------------------------------------------------------------------------
TOTAL PARTNERS' EQUITY 3,527,160 3,101,860
- -------------------------------------------------------------------------------------------------------------------
$ 9,025,681 $ 9,075,687
===================================================================================================================
See accompanying notes to financial statements.
W-3
66
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
STATEMENTS OF INCOME
==============================================================================================================================
Eleven
YEAR ENDED months ended Year ended
NOVEMBER 30, November 30, December 31,
1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------
NET SALES $26,860,546 $24,438,338 $25,364,596
COST OF SALES 7,672,613 7,222,691 7,390,886
- ------------------------------------------------------------------------------------------------------------------------------
Gross profit 19,187,933 17,215,647 17,973,710
EXPENSES (INCOME)
Restaurant operating costs, including amounts to
related parties:
Labor 7,547,115 6,747,046 6,962,082
Occupancy 2,785,973 2,555,026 2,526,139
Advertising 1,638,409 1,535,930 1,519,903
Food service supplies 1,075,263 1,008,536 1,087,791
Royalties 1,074,427 977,508 1,014,569
Other 2,058,380 1,838,291 1,988,597
- ------------------------------------------------------------------------------------------------------------------------------
Total restaurant operating costs 16,179,567 14,662,337 15,099,081
General and administrative expenses, including
amounts to related parties 1,362,199 1,046,177 1,250,468
Depreciation and amortization 858,563 768,653 852,803
Interest expense 431,684 403,435 511,939
Loss on disposal of assets (Note 1) 218,601 25,453 1,097
Other income (287,981) (249,260) (236,309)
Insurance proceeds in excess of net book value of
fire damaged assets -- -- (32,377)
- ------------------------------------------------------------------------------------------------------------------------------
Net expenses 18,762,633 16,656,795 17,446,702
- ------------------------------------------------------------------------------------------------------------------------------
Income before extraordinary item 425,300 558,852 527,008
EXTRAORDINARY ITEM - loss on
extinguishment of debt -- -- (20,536)
- ------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 425,300 $ 558,852 $ 506,472
==============================================================================================================================
W-4
67
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
STATEMENTS OF INCOME
==============================================================================================================================
Eleven
YEAR ENDED months ended Year ended
NOVEMBER 30, November 30, December 31,
1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------
Net income attributed to:
Limited Partners $ 421,047 $ 553,263 $ 501,407
General Partner 4,253 5,589 5,065
- ------------------------------------------------------------------------------------------------------------------------------
$ 425,300 $ 558,852 $ 506,472
- ------------------------------------------------------------------------------------------------------------------------------
Income before extraordinary item per unit of limited
partnership interest (1,256.8 units outstanding) $ 335.02 $ 440.22 $ 415.14
- ------------------------------------------------------------------------------------------------------------------------------
Extraordinary item - loss on extinguishment of debt
per unit of limited partnership interest (1,256.8
units outstanding) $ -- $ -- $ (16.18)
- ------------------------------------------------------------------------------------------------------------------------------
Net income per unit of limited partnership interest
(1,256.8 units outstanding) $ 335.02 $ 440.22 $ 398.96
- ------------------------------------------------------------------------------------------------------------------------------
W-5
68
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
STATEMENTS OF CHANGES IN PARTNERS' EQUITY
==============================================================================================================
Limited General
Partners Partner Total
- --------------------------------------------------------------------------------------------------------------
BALANCE, January 1, 1995 $2,955,865 $(30,682) $2,925,183
Net income for the year 501,407 5,065 506,472
Distributions to partners (565,560) (5,713) (571,273)
- --------------------------------------------------------------------------------------------------------------
BALANCE, December 31, 1995 2,891,712 (31,330) 2,860,382
Net income for the period 553,263 5,589 558,852
Distributions to partners (314,200) (3,174) (317,374)
- --------------------------------------------------------------------------------------------------------------
BALANCE, November 30, 1996 3,130,775 (28,915) 3,101,860
Net income for the year 421,047 4,253 425,300
- --------------------------------------------------------------------------------------------------------------
BALANCE, November 30, 1997 $3,551,822 $(24,662) $3,527,160
==============================================================================================================
See accompanying notes to financial statements.
W-6
69
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
=================================================================================================================
Eleven
YEAR ENDED months ended Year ended
NOVEMBER 30, November 30, December 31,
1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 425,300 $ 558,852 $ 506,472
Adjustments to reconcile net income to net cash
from operating activities:
Loan costs written off due to refinancing -- -- 20,536
Loan costs incurred due to refinancing -- -- (31,477)
Depreciation and amortization 858,563 768,653 852,803
Loss on disposal of property and equipment 218,601 25,453 1,097
Undepreciated cost of equipment destroyed
by fire -- -- 1,194
Decrease (increase) in cash value of
life insurance 61,444 (61,444) --
Increase (decrease) in deferred compensation (61,444) 61,444 --
Changes in operating assets and liabilities:
Receivables (42,403) (161,992) 13,681
Inventories 23,504 (34,443) 16,968
Prepaid expenses (23,558) 13,757 25,429
Accounts payable (178,997) (14,585) (8,681)
Accrued salaries and wages 19,291 44,276 21,391
Accrued taxes (8,844) (26,007) (35,821)
Accrued percentage rent (19,171) 27,441 (6,580)
Other current liabilities 12,946 (417) (11,234)
- -----------------------------------------------------------------------------------------------------------------
Net cash from operating activities 1,285,232 1,200,988 1,365,778
- -----------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Proceeds from disposal of property and equipment -- 5,449 122,500
Additions to property and equipment (572,906) (427,872) (471,092)
Payment of franchise fees (10,000) -- (50,000)
Purchase of other assets (11,106) (8,784) --
- -----------------------------------------------------------------------------------------------------------------
Net cash for investing activities (594,012) (431,207) (398,592)
- -----------------------------------------------------------------------------------------------------------------
W-7
70
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
=================================================================================================================
Eleven
YEAR ENDED months ended Year ended
NOVEMBER 30, November 30, December 31,
1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Proceeds from long-term debt $ -- $ -- $ 2,022,499
Repayment of short-term notes payable -- -- (102,724)
Repayment of long-term debt (251,282) (307,989) (2,537,612)
Payments made on obligations under
capital leases (232,442) (161,550) (142,920)
Distributions to partners -- (317,374) (571,273)
- -----------------------------------------------------------------------------------------------------------------
Net cash for financing activities (483,724) (786,913) (1,332,030)
- -----------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH 207,496 (17,132) (364,844)
CASH, beginning of period 394,066 411,198 776,042
- -----------------------------------------------------------------------------------------------------------------
CASH, end of period $ 601,562 $ 394,066 $ 411,198
=================================================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION
Cash paid for interest expense $ 437,014 $ 408,680 $ 499,673
=================================================================================================================
NONCASH INVESTING AND FINANCING TRANSACTIONS
Long-term debt incurred for purchase of
equipment $ 244,637 $ -- $ --
Capital lease obligation incurred for use
of equipment -- 379,591 --
Retirement of note payable - bank with new
revolving term note payable - bank -- -- 1,331,221
=================================================================================================================
See accompanying notes to financial statements.
W-8
71
WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
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1. SUMMARY OF ORGANIZATION
SIGNIFICANT
ACCOUNTING Wendy's of West Michigan Limited Partnership
POLICIES (Partnership) is a Michigan limited
partnership organized on July 31, 1986. The
Partnership presently operates 25 Wendy's Old
Fashioned Hamburger restaurants in western
Michigan under franchise agreements with
Wendy's International, Inc. In August 1997,
the Partnership closed one of its restaurants
due to continuing operating losses. As a
result of this restaurant closing and the
Partnership not exercising its option to
extend its lease of the restaurant building,
the Partnership incurred a loss on disposal
of assets of $197,102.
Subject to the consent of the Limited
Partners where required by the Partnership
Agreement, the General Partner has the
exclusive right to manage the Partnership.
The Limited Partners are not liable for
Partnership debts beyond the amount of their
original contributions and share of
undistributed net profits. The financial
statements do not reflect assets the partners
may have outside their interests in the
partnership, nor any personal obligations,
including income taxes, of the individual
partners.
The Partnership Agreement provides that the
Limited Partners (as a group) are to share in
99% of the Partnership's net income or loss,
except as discussed in the following
paragraph, and receive 99% of all cash flow
from operations as defined by the Partnership
Agreement.
The net profits of the Partnership arising
from the sale or other disposition, whether
as a result of foreclosure, condemnation or
otherwise, of all or part of the property,
shall be allocated among the Partners in
accordance with the provisions of the
Partnership Agreement.
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A Partnership administration fee is payable
to the General Partner equal to 2% of gross
partnership revenues from operations, as
defined in the Partnership Agreement. The
General Partner has elected to reduce the
Partnership administration fee to the General
Partner from 2% of gross partnership revenues
from operations to $160,000, $146,667 and
$160,000 for 1997, 1996 and 1995,
respectively.
The Partnership shall exist until December
31, 2026, unless terminated sooner as
provided in the Partnership Agreement (see
Note 7). A Limited Partner may, in accordance
with the agreement, assign his/her interest
in the Partnership by a properly executed and
acknowledged instrument, the terms of which
are not inconsistent with or contrary to the
provisions of the Partnership Agreement and
are otherwise satisfactory to the General
Partner, subject to the approval of the
General Partner.
During the period ended November 30, 1996,
MHG Food Service Inc. (MHG), a wholly owned
subsidiary of Meritage Hospitality Group Inc.
(Meritage), acquired 680.8 units of limited
partnership interest, representing
approximately 54% of the outstanding limited
partner units. As a result, the Partnership
changed its fiscal year-end to November 30 to
conform with Meritage's fiscal year-end.
CONCENTRATION OF CREDIT RISK
Competition in the quick-service restaurant
industry is intense. Most of the
Partnership's restaurants are in close
proximity to other quick-service restaurants
which compete on the basis of price, service
and product quality and variety. The General
Partner believes that the Partnership
competes effectively in these areas.
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
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USE OF ESTIMATES
The preparation of financial statements in
conformity with generally accepted accounting
principles requires management to make
estimates and assumptions that affect the
reported amounts of assets and liabilities
and disclosure of contingent assets and
liabilities at the date of the financial
statements and the reported amounts of
revenues and expenses during the reporting
period. Actual results could differ from
those estimates.
INVENTORIES
Inventories are stated at the lower of cost
(first-in, first-out) or market. Inventories
consist of restaurant food items and food
serving supplies.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost.
Expenditures for renewals and betterments
which extend the originally estimated
economic life of assets are capitalized.
Expenditures for maintenance or repairs are
charged to expense when incurred. For
financial reporting purposes, depreciation is
computed using the straight-line method over
the estimated economic lives of the assets.
For tax purposes, useful lives and methods
are used as permitted by the Internal Revenue
Code. Amortization of leasehold improvements
is provided over the primary terms of the
various leases.
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED
ASSETS
In 1995, the Partnership adopted Statement of
Financial Accounting Standards (SFAS) No.
121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets
to be Disposed of. This statement requires
that long-lived assets and certain
identifiable intangibles to be held and used
by an entity be
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reviewed for impairment whenever events or
changes in circumstances indicate that the
carrying amount of an asset may not be
recoverable. This statement also requires
that long-lived assets and certain
identifiable intangibles to be disposed of be
reported at the lower of carrying amount or
fair value less cost to sell. This new
accounting standard had no impact on the
financial statements.
OTHER ASSETS
Franchise fees for restaurant units are being
amortized over the terms of the individual
restaurant franchise agreements. Loan costs
are being amortized over 120 months, the
period of the loan. All amortization is under
the straight-line method.
The excess of cost over fair value of net
assets acquired (goodwill) is being amortized
on the straight-line method over 240 months.
Amortization expense for goodwill for the
periods 1997, 1996 and 1995 amounted to
$198,120, $181,610 and $198,120,
respectively. The Partnership evaluates the
recoverability of the goodwill whenever
events or changes in circumstances indicate
that the carrying amount of goodwill may not
be recoverable and considers whether the
goodwill should be completely or partially
written off or the amortization period
accelerated. The Partnership assesses the
recoverability of goodwill based on
undiscounted estimated future operating cash
flows. If the Partnership determines that the
carrying value of the goodwill has been
impaired, the measurement of the impairment
will be based on discounted estimated future
operating cash flows.
FRANCHISE COSTS AND OTHER ADVERTISING COSTS
Royalties and national advertising costs are
based on a percentage of monthly sales. These
costs and other advertising costs are charged
to operations as incurred.
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CAPITALIZED LEASE OBLIGATIONS
Lease transactions relating to certain
restaurant buildings and equipment are
classified as capital leases. These assets
have been capitalized and the related
obligations recorded based on the fair market
value of the assets at the inception of the
leases. Amounts capitalized are being
amortized over the terms of the leases.
INCOME TAXES
No provision for income taxes has been made
in the accompanying financial statements. A
Partner's share of the income or loss of the
Partnership is includable in the individual
tax returns of the Partners.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Partnership's
financial instruments, consisting of cash,
receivables, accounts payable and long-term
debt, approximate their fair value.
2. DEFERRED The Partnership had a deferred compensation
COMPENSATION agreement with a key employee which provided
for the payment of $150,000 upon the
completion of the five-year term of the
agreement in December 1998. The agreement was
funded by the Partnership through payment of
premiums on a split dollar life insurance
contract. The agreement was terminated in
April 1997. Charges to operations related to
this agreement were $10,630, $27,913 and
$25,295 for 1997, 1996 and 1995,
respectively.
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
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3. LONG-TERM DEBT Long-term debt at November 30, 1997 and 1996
consisted of the following:
November 30, 1997 1996
-------------------------------------------------------------------------
Revolving term note payable - bank $2,037,111 $2,192,351
Equipment note payable 148,594 --
-------------------------------------------------------------------------
2,185,705 2,192,351
Less current maturities 126,294 --
-------------------------------------------------------------------------
Long-term debt, less current maturities
$2,059,411 $2,192,351
-------------------------------------------------------------------------
The revolving term note payable - bank is
secured by substantially all assets of the
Partnership and by the unsecured corporate
guaranty of Meritage. The loan agreement
requires monthly payments of $43,313,
including interest at 1% over prime
(effectively 9.5% at November 30, 1997)
through February 2005 when any remaining
unpaid principal will be due. Under the
revolving loan agreement, the required
monthly payments described above may be
offset by additional borrowings up to the
unused available borrowings. The total
available borrowings under the loan agreement
were $2,727,802 as of November 30, 1997. The
total available borrowings decrease monthly
based on the original term note amortization
over 120 months. The loan agreement also
requires that the Partnership maintain
certain cash availability, financial ratios
and a minimum tangible net worth, as defined
in the loan agreement, of approximately
$968,000. The Partnership was in compliance
with these covenants at November 30, 1997.
The loan agreement also requires that the
Partnership not exceed $400,000 of capital
expenditures in any one year. During 1997,
the Partnership's capital expenditures
exceeded the covenant. The bank agreed to
waive the covenant for 1997.
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The equipment note payable is unsecured and
requires monthly payments of $11,290,
including interest at 10% through January
1999.
The following is a schedule by year of annual
maturities under the loan agreements:
Year ending November 30,
---------------------------------------------
1998 $ 126,294
1999 22,300
2000 232,940
2001 375,677
2002 415,587
Later years 1,012,907
---------------------------------------------
$2,185,705
----------------------------------------------
4. DESCRIPTION OF The Partnership leases land and buildings
LEASING used in operations under operating
ARRANGEMENTS agreements, with remaining lease terms
(INCLUDING THOSE (including renewal options of up to thirteen
WITH AFFILIATED years) ranging from one to twenty-three
PARTNERSHIP) years. Included in the leases are five leases
with parties related through common ownership
with the former general partner. (See Note
6.)
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Total lease expense (including taxes,
insurance and maintenance when included in
rent) related to all operating leases and all
percentage rentals is as follows:
Period ended 1997 1996 1995
-----------------------------------------------------------------------
Leases with related parties:
Minimum rentals $ 143,127 $ 266,358 $ 230,848
Percentage rentals 79,948 168,370 150,867
Other leases:
Minimum rentals 583,365 403,613 414,539
Percentage rentals 459,463 275,993 309,228
-----------------------------------------------------------------------
$1,265,903 $1,114,334 $1,105,482
=======================================================================
Certain restaurant leases (eight restaurant
buildings, excluding land which is accounted
for as an operating lease) and equipment
leases have been capitalized. Minimum future
obligations under capital leases and
noncancelable operating leases in effect are
as follows:
Capital Operating
Year ending November 30, leases leases
------------------------------------------------------------------------
1998 $ 465,323 $ 590,008
1999 465,323 445,516
2000 465,323 430,693
2001 449,365 409,622
2002 369,575 332,490
Later years 400,373 308,263
------------------------------------------------------------------------
Total minimum lease obligations 2,615,282 $2,516,592
==========
Less amount representing interest imputed
at approximately 11% 661,282
----------------------------------------------------------
Present value of minimum lease obligations $1,954,000
==========================================================
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WENDY'S OF WEST MICHIGAN LIMITED PARTNERSHIP
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The present value of minimum rental
obligations is reflected in the balance
sheets as current and long-term obligations
under capital leases.
Accumulated amortization of leased property
under capital leases was $1,814,346 and
$1,648,146 at November 30, 1997 and 1996,
respectively.
In addition to minimum future obligations,
percentage rentals may be paid under all
restaurant leases on the basis of percentage
of sales in excess of minimum prescribed
amounts.
5. PROFIT-SHARING The Partnership maintains a 401(k)
PLAN profit-sharing plan. The plan covers
substantially all employees of the
Partnership who are at least 21 years old and
who have completed at least one year of
service (of at least 1,000 hours) with the
Partnership. Contributions to the plan may be
made by the Partnership (which are purely
discretionary in nature) or by plan
participants through elective salary
deductions. Contributions to the plan by the
Partnership for the periods ended 1997, 1996
and 1995, totaled $22,000, $30,721 and
$12,000, respectively.
6. LEGAL PROCEEDINGS On May 19, 1997, a majority limited interest
of the Partnership removed Wendy's West
Michigan, Inc. as general partner of the
Partnership and appointed MCC Food Service
Inc. (MCC), an affiliate of Meritage, as the
substitute general partner. Approximately 180
unit holders (from whom MHG Food Service Inc.
(MHG) acquired 482.55 of its total
partnership units) had previously consented
to the removal and substitution of the former
general partner. This action was carried out
in connection with MHG's prior acquisition of
a controlling interest in the Partnership.
The former general partner subsequently
commenced a lawsuit against Meritage and its
affiliates seeking, among other things, (i) a
declaration that Wendy's West Michigan, Inc.
is the general partner of the Partnership,
(ii) injunctive relief in the form of a
temporary restraining order or a preliminary
injunction which would prohibit the
defendants from participating in the
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management of the Partnership, (iii)
unspecified damages for breach of contract,
and (iv) unspecified damages for various
business torts and misrepresentation. The
former general partner's motion for a
temporary restraining order was denied on May
21, 1997. In September 1997, the Partnership,
Meritage and certain of its affiliates filed
claims against the former general partner and
its principal shareholders alleging (i)
breach of contract, (ii) violation of SEC
Rule 10b-5, (iii) business defamation, (iv)
tortious interference, and (v) breach of
fiduciary duty. In January 1998, the former
general partner filed a motion to enjoin the
dissolution of the Partnership. The court
denied this motion and the Partnership was
thereafter dissolved on January 30, 1998.
Wendy's International, the franchisor, has
consented to MCC serving as the general
partner of the Partnership and to the
dissolution of the Partnership. Management
believes there is no basis for the
Plaintiffs' claims but cannot at this time
predict the likely outcome of this
litigation. It is management's opinion that
these proceedings are not expected to have a
material adverse effect on the Partnership's
operations or financial position.
7. DISSOLUTION OF Through the filing of Form S-4 with the
PARTNERSHIP Securities and Exchange Commission, which was
effective on November 25, 1997, the holders
of limited partnership units of the
Partnership were notified of the sale of all
the assets of the Partnership to a limited
partnership affiliated with Meritage and the
subsequent dissolution of the Partnership. As
a result of the transaction, on January 30,
1998, the newly formed limited partnership
acquired all the assets and assumed all the
liabilities of the Partnership and succeeded
to all business operations that had been
conducted by the Partnership. Upon
dissolution, Meritage common shares were
distributed to non-affiliated limited
partners on the basis of that number of
Meritage common shares that had a value of
$7,500 per unit, based on the average high
and low bid price quoted on the OTC Bulletin
Board for the 10 trading days preceding the
date of dissolution ($2.4375 per share).
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